Al-Shal: Tying interest rates to the Fed's decision and keeping them stable is the lesser of two evils for Gulf economies
Al-Shal noted in his report that the U.S. Federal Reserve decided at its meeting on Wednesday, July 29, to keep the base interest rate on the U.S. dollar unchanged, a decision supported by key U.S. economic indicators through the end of June.
Inflation fell by approximately 0.4%, dropping to an annual rate of 3.5% from 4.2% in May. The labor market remained stable, and economic growth hovered around 2%. In reviewing the inflation data, it is evident that it is primarily linked to the energy price index within it. Its previous rise was driven by increases in the energy price index of 10.9% in March, 3.8% in April, and 3.9% in May, while the decline in June was almost entirely attributable to a 5.7% drop in the energy price inflation index.
Between the end of June and the Federal Reserve’s meeting on July 28–29, a major development occurred: the memorandum of understanding between the United States and Iran was canceled, and armed operations resumed. Although not at the same level as previous escalations, these developments could alter all previously stable economic indicators.
As a result, the U.S. gasoline price per gallon returned to $4.11, signaling a strong and potential resurgence in energy inflation. Amid uncertainty regarding the war’s outcome, risks have doubled. Consequently, the ceasefire was declared for the second time approximately a week before the Federal Reserve meeting, likely in an attempt to encourage the Fed to maintain interest rates. Hostilities resumed immediately after the rate-hold decision.
This time, perhaps anticipating the ceasefire’s fragility, the rate-hold decision was not unanimous; it was approved by nine members and opposed by three. The dissenters preferred a quarter-point interest rate hike. This indicates that future interest rate decisions will be dictated by geopolitical developments, whereas at the beginning of the year, rate cuts were anticipated. Rate cuts have now become a genuine necessity for the United States and most countries worldwide.
What Gulf economies need least is a return to armed conflict. Their economies are heavily dependent on two factors: first, their forced involvement in this war by Iran, and second, their inability to sell their oil, which constitutes their primary source of foreign exchange earnings.
Despite facing difficult economic and financial conditions that necessitate reducing financing costs through lower interest rates on their currencies and the U.S. dollar, they have no choice but to fully align with the Federal Reserve’s decision and maintain interest rates on their currencies. This is what their central banks did, choosing the lesser of two evils.
Therefore, to prevent deepening negative impacts on their economies and public finances, they must leverage all their political weight, in a unified manner, to transform the current ceasefire into a permanent one leading to a final agreement. This issue is existential for them, with full respect and understanding for their feelings of pain and anger.
