The National - What does the US Federal Reserve's interest rate rise mean for UAE residents?

Vijay Valecha, Special to The National May 05, 2022

Consumers will pay more to borrow money after the US Federal Reserve’s decision on Wednesday to raise interest rates by 50 basis points, its most aggressive move since May 2000 to rein in inflation, financial experts say.

The 50 basis point increase takes the Fed's key rate to a range of 0.75 per cent to 1 per cent, with the committee saying it will consider further large rate hikes.

The Fed's move is its second in less than three months as the job market continues to overheat and inflation reached 8.5 per cent in March, the highest level since 1981.

Central banks are no longer seeking to ensure "cheap money" is available for households, companies and governments to borrow at “exceptionally favourable rates” as they did during the Covid-19 pandemic, said 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 Central Bank of the UAE also increased its base rate for the overnight deposit facility by half a percentage point. The CBUAE maintained the rate applicable to borrowing short-term liquidity from the regulator through all standing credit facilities at 50 basis points (bps) above the base rate, it said in a statement on Wednesday.

The base rate, which is anchored to the Fed's interest on reserve balances, signals the general stance of the central bank's monetary policy and provides an effective interest rate floor for overnight money market rates.

The Fed's rate increase 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 at 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- and five-year fixed rates are currently at 2.49 per cent and 2.99 per cent respectively, while variable rates start at 2.35 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.

“The quarter basis point hike [in March] 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.

How high can interest rates go?

The Fed is expected to raise interest rates at its five remaining meetings this year.

“We expect that the Fed will follow in June with another 50 bps hike and at least 100 bps more hikes by the end of the year,” Emirates NBD said in a research note.

“That will bring the Fed Funds rate at the end of 2022 to 2.5 per cent, up from our previous expectation of 2 per cent. In addition to higher rates, the Fed will also start to run down its balance sheet at a monthly pace of $95 billion, helping to tighten liquidity conditions further.”

In April, the Economist Intelligence Unit forecast a total increase of 225 bps this year, with another half-point rise in June.

"After two more quarter-point rate rises in the first quarter of 2023, the Fed's main target rate will reach 2.9 per cent," the EIU said on April 25.

When will consumers feel the pinch?

In the short term, consumers may feel the sting of higher prices more acutely than the pinch of interest rate rises, 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.”