Arabian Business - What will impact UAE consumers more: Rising interest rates or higher prices due to inflation?

Vijay Valecha, Special to Arabian Business May 05, 2022

The UAE Central Bank has raised interest rates, following the US Federal Reserve’s decision to increased the interest on reserve balances (IORB) by 50 basis points for the first time in over two decades.

The US Federal Reserve’s “aggressive rate hike decision” is in line with efforts to stop the economy from overheating and reduce inflation that is running at its highest levels in four decades, experts said told Arabian Business.

“The Fed rate hike will be reflected on all loans and mortgages. A half a basis point hike may not immediately deter consumers from borrowing less as it would have only a marginal impact on their interest payments,” Vijay Valecha, the chief investment officer at Century Financial explained.

“For now, consumers may feel the sting of higher prices (due to inflation) more acutely than the pinch of a half-point bump.”

However, the US Federal Reserve Chair Jerome Powell has also stated that similar rate hikes are on the cards for June and July, in order to curb surging inflation.

Taking this into consideration, Valecha adds: “Gradual hikes this year may lower consumers’ willingness to borrow at the then high-interest rates. Additionally, people may opt to spend less as many consumers in UAE spend using credit cards – and credit card debt is especially susceptible to climbing interest rates.”

As a result, continuing rate hikes from the central banks will result in consumers eventually paying more.

“Stack several rates increases together and consumers will start to feel the pressure. Markets are expecting a series of rate increases this year, which would then start affecting consumers purchasing decisions,” Valecha added.

“This move will result in higher borrowing costs in turn causing consumers to spend less and ultimately cooling the pressure on prices.”

Eventually, higher interest rates will help temper inflation, which will benefit consumers in the long run.

The macro strategist at Lombard Odier, Stéphanie de Torquat, said: “This time around, the move to accelerate the tightening cycle is opportune for the UAE. Economic conditions and cycles in the US and UAE do not always align. Today, however, with high oil prices having rapidly boosted regional economies, and inflation also picking up, curbing activity through higher rates is not an issue.

“While CPI growth in the UAE is much lower than that in the US, many of the factors driving US price pressures are also an issue in the Emirates, including much higher imported food prices, and renewed bottlenecks in global supply chains following China’s Covid lockdowns.”

The Switzerland-headquartered Lombard Odier does not see higher interest rates as posing a problem for economic activity in the region this year.

“We forecast above-trend growth in the mid-single digits for the UAE, as well as solid fiscal and external surpluses, thanks to the boost from higher oil prices, and an ongoing recovery in the property market,” Stéphanie de Torquat added.

From a banking and financial services perspective, the UAE’s decision to hike interest rates in tandem with the US Federal Reserve is expected to benefit local banks.

“In the rising interest rate environment, banks’ net interest margins increase, which will improve their bottom-line items,” Valecha concluded.