DUBAI, (Reuters) – Saudi inflation hit 6.5 percent in December, its highest level in at least 12 years, leaving the world’s top oil-exporter with negative interest rates as its central bank faces the prospect of matching more U.S. rate cuts.
Inflation in the largest Arab economy, which has been rising since May, accelerated from 6 percent year-on-year in November when rents surged more than 15 percent, data provided by the Central Department of Statistics showed on Wednesday.
The cost of living index was 110.2 points on Dec. 31 compared with 103.5 points a year earlier, an official at the Ministry of Economy and Planning said, declining to be identified. He would not give details.
The central bank is constrained in the fight against inflation by the riyal currency’s peg to the dollar, which forces it to track U.S. monetary policy at a time when the U.S. Federal Reserve is cutting interest rates.
The Fed has slashed its benchmark rate by 100 basis points since Sept. 18 and Saudi Arabia has followed by cutting its reverse repurchase rate, which banks use to determine deposit rates, to 4 percent. The fed funds rate is 4.25 percent.
Saudi Arabia has tried not to lower borrowing costs by leaving its benchmark repurchase rate, used by banks to set lending rates, steady at 5.5 percent.
With inflation now higher than official interest rates, it becomes cheaper for Saudis to borrow than keep money in bank deposits where they get negative real returns, said John Sfakianakis, chief economist at SABB bank, an HSBC affiliate in Saudi Arabia.
“Saudi Arabia has now joined other countries in the region with negative interest rates, which has the tendency to fuel real estate price inflation,” he said.
“Rents are a big part of this. Negative rates will fuel real estate price inflation in the economy,” he said.
Rents were the main driver of inflation in November, jumping 15.4 percent, compared with 11.7 percent a month earlier, data showed.
Food price inflation was steady in November at 7.5 percent.
“Dollar pegs mean that the Gulf region effectively lacks the policy flexibility to deal with the economic problem of rising inflation,” Standard Chartered said in a statement.
The dollar hit a 2-1/2 year low against the yen and a record low against the Swiss franc on Wednesday on fears of a U.S. recession and speculation about Fed rate cuts.
A majority of Wall Street firms expect the Fed to lower borrowing costs by 50 basis points at a policy meeting later this month, a Reuters poll showed on Friday.
The riyal hit a 21-year high last year when the Saudi central bank initially declined to match a Fed cut in September, firing speculation that the kingdom would sever its dollar peg.
The central bank says it has no plans to change currency policy and has since matched every Fed move by cutting some rates.
While oil producers are unlikely to drop their dollar pegs, an 8 percent appreciation in the Saudi riyal is likely before April if the U.S. dollar weakens further, Standard
Kuwait has allowed its dinar to rise almost 6 percent since it broke ranks with its neighbors in May and severed its dinar’s link to the dollar to track a currency basket partly to help contain imported inflation.
Average inflation in Saudi Arabia could rise to 4.1 percent in 2008 from 3.8 percent in 2007, a Reuters poll showed last month.