UAE Inflation Rise Gradually Through 2012

UAE inflation is projected to increase gradually through the second half of this year, the latest study by Dubai Chamber of Commerce finds. Base effects will become visible, particularly in the second half of this year, which will help increase inflation, while recent wage increases are likely to support domestic demand further, putting rising pressure on prices, according to the study.

The downward trend in international food prices (see Figure 1 below) and the expectation of a stronger US dollar for the next 12 months, however, are expected to diminish pressure on prices. In addition, with growth in bank credit and broad money still recovering, it is not expected that the monetary authorities will take any policy action. In fact, according to Central Bank officials, inflation is not a worry in the UAE since the sources of inflation are under control, the study states. After averaging 12.3% in 2008, the UAE headline rate of consumer price inflation fell to 1.6% in 2009. At the end of December 2010, consumer price inflation recorded a historical low since 1990. According to the UAE National Bureau of Statistics (NBS), inflation stood at 1.7% year on year in December 2010, compared to 2.0% the previous month.

Although this low level reflected the contraction in housing costs as a result of the downturn, and given the fact that the real estate sector remained subdued in 2011, housing and rental costs have more or less bottomed out. Having said that, it will be a sluggish process before housing costs start rising significantly, and it is anticipated that consumer price growth will remain at relatively low levels, reaching 2.5% in 2011 and 2012 (projection by the International Monetary Fund), according to the study. Moreover, potential house price growth will be offset by the impact of the strengthening US dollar, which in turn will support keep import prices down, although a recovering global economy will eventually put upward pressure on commodity prices.

In addition, money supply data indicated that money supply growth at the end of 2010 (6.2% for Money Supply, M2) was the lowest for over a decade, thus easing any price pressures. However, in the longer term if inflation were to increase significantly, it would raise concerns over the policy of pegging the UAE dirham to the US dollar. This would inevitably imply that the UAE cannot use interest rates to help control inflation. Furthermore, a weak US dollar helps feed imported inflation and also results in an increase in the inflows of speculative funds betting on a revaluation, adding further inflationary pressures as well as destabilising the economy.

Monetary policy was used to stimulate the economy in 2009. The key objective of the UAE’s monetary policy, as with certain other GCC peers in the Gulf region, is to preserve a fixed (peg) exchange rate to the US dollar. Such a policy implies that controlling inflation becomes a matter of secondary importance, while emphasis on the fixed exchange rate has resulted in the loss of control over some monetary factors. In simple words, the government cannot utilise policy interest rates to control money supply. That is, the movement of domestic policy interest rates must reflect those of US interest rates in order to preserve the relative value of the currencies, the study states.

A period of high inflation in 2007/2008 led to severe speculation that the authorities might revalue the dirham. However, this was repelled, particularly as the currency peg has soundly served the UAE since 1978. With inflationary pressures bottoming out, there is now minimal pressure on the authorities to contemplate an alternative exchange rate arrangement, which will continue to act as a consistent anchor for the economy. And, with the UAE having withdrawn from the GCC project to establish a currency union, the dirham is expected to remain pegged to the US dollar in the years to follow. According to the UAE National Bureau of Statistics (See Table 1 below), during February 2012 inflation slowed slightly to 0.6% year on year (-0.4% month on month), compared with 0.7% year on year (0.3% month on month) in the previous month.

Housing prices remain deflationary, subtracting 1.5 points from the overall index, while food still remains the main contributor to upward inflation, adding 1.1 percentage points to the annual headline figure. On a month on month basis, housing prices fell 0.7% in February 2012, while the month-on-month change in food prices also deteriorated. Core inflation in the UAE, which excludes food and housing, decreased slightly in February 2012, to 1.9% year on year compared with 2.1% year on year in the previous month. UAE inflation remains the second lowest in the GCC. Evident to that, the GCC’s weighted average inflation stood at 3.7% year-on-year in January 2012. Housing deflation in Bahrain, Qatar and the UAE continues to strain the weighted GCC consumer price inflation downward. On the other hand, weighted GCC food inflation continues an upward trend, registering 4.9% year on year in January 2012.