The National - What does the US Fed rate rise mean for UAE residents?

The US Federal Reserve’s decision on Wednesday to raise interest rates by 25 basis points for the first time since 2018 signals the end of the “cheap money” era for consumers.

Central banks are no longer seeking to ensure money is available for households, companies and governments to borrow at “exceptionally favourable rates” as they did during the Covid-19 pandemic, Vijay Valecha, chief investment officer at Century Financial.

“During the pandemic, cheap money was provided to help the economy sustain itself; however, as economies are recovering gradually, the availability of quick money would reduce consumer spending as the cost of borrowing has increased,” he said.

The UAE Central Bank raised its overnight deposit facility after the Fed's move by a quarter of a percentage point. However, it kept the rate applicable to borrowing short-term liquidity through all standing credit facilities at 50 bps above the base rate.

The Fed's rate increase from near zero comes amid an uncertain global economic outlook fuelled by record-high inflation and Russia’s worsening military assault on Ukraine that has affected commodities markets.

However, the strength of the UAE’s recovery from the pandemic means its economy is well placed to deal with higher rates, said Monica Malik, chief economist at Abu Dhabi Commercial Bank.

“Borrowing costs will rise further, with the Fed firmly focusing on inflation,” Ms Malik said.

Higher rates mean a range of personal finance products — from loans to credit cards, mortgages, savings and remittances — will be affected. Here is a look some of the effects:

Mortgages

For mortgage borrowers who have yet to secure a fixed rate, the news might be a concern, said Mohamad Kaswani, managing director at Mortgage Finder.

“However, this has been on the cards for a while, so it shouldn’t come as a real shock. The good news is that even with this recent increase, rates are still at historic lows and there is time to secure a fixed rate before any further hikes later in the year.”

For borrowers on fixed-rate home loans, there should be no changes to their mortgage payments until they come to the end of their fixed-rate period, Mr Kaswani said. However, borrowers on variable rate mortgages will feel the change as soon as their next monthly payment is due, he said.

“Most banks use [the] three-month Emirates Interbank Offered Rate [Eibor], so borrowers will see the change at the end of this month. For those who would prefer more stability moving forward, they can investigate moving on to a fixed-rate mortgage.”

The best three-year fixed rates are currently sitting between 2.75 per cent and 2.99 per cent while variable rates are still available as low as 1.85 per cent, according to Mortgage Finder.

Credit cards

Interest rates on credit cards in the UAE are already high at more than 30 per cent a year and this type of debt is particularly susceptible to rising rates, according to Century Financial's Mr Valecha.

“Credit card debt already has its own high interest rate, so rate hikes from the central banks will result in consumers eventually paying more on any revolving debt,” he said.

“Now that the Central Bank of the UAE has hiked the interest rates, changes to credit card interest rates typically follow, usually within a billing cycle or two.”

Most credit cards have a variable interest rate, which means there is a direct connection to the Fed's benchmark rate, Mohammed Shaheen, chief executive of broker Seven Capitals, said.

Borrowers with revolving debt should find a zero-interest balance transfer credit card while they can and start to pay down the balance, Mr Shaheen said.

“In other words, people can look to use this opportunity to get themselves out of a debt,” he said.

Loans

Monthly instalments on personal loans and car financing will also rise.

However, the interest rate a borrower will pay depends on a range of factors such as credit history, the type of vehicle they buy, the loan term and down payment.

“A quarter basis point hike will not deter consumers from borrowing less as it will not have a significant impact on their interest payments,” Mr Valecha said.

“However, gradual hikes this year will lower consumers' willingness to borrow at high interest rates.”

Savings

The historically low interest rates over the past few years has affected savings accounts. But following the UAE Central Bank's rate increase on Wednesday, consumers can expect a marginal increase that will boost their savings power.

“However, putting extra money into your savings might not result in as much interest earned from other avenues,” Mr Valecha said.

“Investors can use the higher interest rates as an incentive to boost their savings or emergency fund contributions.”

While traditional banks might be slower to pass on the rate rise to savers, consumers could look at other ways to boost their savings power, Mr Shaheen of Seven Capitals said.

“Online banks offering high-yield accounts tend to pay higher rates than traditional banks,” he said.

Remittances

The interest rate rise is unlikely to have much of an impact on remittances, said Nagesh Prabhu, deputy general manager of treasury at LuLu Exchange.

“Since the rupee has recovered, Indians in the UAE would not be eager to remit. Most remittances occurred when the UAE dirham and rupee was around 20.75 to 20.80. People are eagerly awaiting the 21 mark per dirham,” he said.

Similarly, people from other countries might hold off for a few days before remitting large amounts, Mr Prabhu said.

How high can interest rates go?

The Fed has signalled further increases of at least 25 bps at its six remaining meetings this year.

This means the US benchmark rate could end the year at about 1.9 per cent and then rise to about 2.8 per cent in 2023.

However, it could be higher, said Ipek Ozkardeskaya, a senior analyst at Swissquote.

“Swaps linked to the next Fed announcement dates suggest that we will see a 75 bps increase in the next two meetings, meaning that we could see a 50 bps hike in one of them,” she said.

When will consumers feel the pinch?

In the short term, consumers may feel the sting of higher prices more acutely than the pinch of a quarter-point rise, Mr Valecha said.

But as the Fed continues its rate increase programme throughout the year, consumers will begin to feel the effect, he said.

“Eventually higher rates will help cool down inflation, which will benefit consumers in the long run.”