How will the Fed’s easing cycle affect the Gulf? Via Investing.com

Investing.com — The U.S. Federal Reserve’s impending easing cycle is expected to spill over to Gulf economies as those countries’ central banks are forced to follow the Fed’s lead due to dollar pegs and open capital accounts, according to a recently Capital Economics. note.

While lower interest rates may provide some relief in terms of debt service costs, the overall impact on growth in the Gulf is expected to be limited.

US-based Capital Economics believes the Fed will cut the federal funds rate by 25 basis points at its September policy meeting, with further cuts to follow, totaling 200 basis points by the end of 2025. As a result, central banks in Golf will lower their own rates because of their dollar.

“The so-called ‘impossible trinity’ means that due to the commitment to fixed exchange rates and the free movement of capital across borders, interest rates in the Gulf must follow those in the US,” the firm explains.

“Interbank interest rates closely track those in the US, albeit by a margin that reflects a premium demanded by investors to hold the local currency instead of dollars.”

There are two main ways that looser monetary policy will affect the Gulf.

First, lower interest rates will reduce debt servicing costs for businesses and households, providing opportunities to refinance or take out new loans at a lower rate. In the case of Saudi Arabia, where many loans are at variable rates, this should provide significant relief, potentially alleviating concerns about rising bad loans.

Second, lower interest rates will affect incentives to save and borrow. The report points out that as the return on savings falls, households may be less inclined to save, boosting consumption. At the same time, borrowing costs will fall, which should, in theory, lead to an increase in credit demand.

However, Capital Economics warns of the potential for significant credit growth.

“Interest rates are likely to remain high by past standards,” and historical data suggests that oil prices, rather than interest rates, are the main driver of credit growth in the Gulf. High oil prices tend to improve fiscal conditions and boost non-oil sectors, creating a more favorable environment for borrowing. But with oil currently at $72 a barrel and not expected to rise above $75 in the coming years, the impetus for credit growth is likely to be subdued.

Overall, the note concludes that while the Fed’s easing cycle will bring lower interest rates to the Gulf, the broader economic impact will be limited. Capital Economics expects non-oil GDP growth in the region to slow, particularly as fiscal policy becomes less supportive in the coming years.