The world’s largest oil exporter largely moves in lockstep with the US to protect its currency peg to the dollar. On Wednesday, its central bank raised the repo rate by half a percentage point to 2.25%, compared with the Fed’s 75-basis-point increase.
“While higher interest rates are probably appropriate for Saudi Arabia and the rest of the Gulf given growth momentum and inflation trends, they probably don’t need to rise as fast as the Fed is increasing them,” said Scott Livermore, chief Middle East economist at Oxford Economics.
The US is hiking rates to tackle inflation soaring to the highest in decades, but price gains in Saudi Arabia have been less intense. That’s partly due to the effect of tripling value-added tax in 2020 and a cap on domestic fuel prices introduced last year.
Saudi Arabia also needs to tread more carefully in raising the cost of money because its banks are facing the tightest liquidity conditions since 2008. It’s already taking a more conservative approach to fiscal spending, pledging to wait until the end of the year and only then distribute the oil windfall earned thanks to a boom in crude prices.
“This has resulted in the divergence of local monetary policy from the Fed, as central banks across the Gulf try to balance domestic inflation expectations — modest compared with the US given high oil prices — the need to retain dollar liquidity and their ability to support their currency peg to the dollar,” said Bloomberg Intelligence analysts Edmond Christou and Lea El-Hage.
Inflation in the kingdom slowed last month and is expected to end the year at 2.5%, according to the International Monetary Fund, a level that would be among the lowest in the world.
The economy is expanding at the strongest pace in over a decade, set to become the fastest-growing this year in the Group of 20 after India, according to Bloomberg’s surveys of analysts
Saudi Arabia and Gulf nations have seen a reversal in fiscal fortunes with global benchmark Brent averaging above $100 a barrel. Budgets were under pressure in 2020, when oil prices slumped and the coronvirus pandemic was raging.
The influx of billions in petrodollars is now a source of reassurance in Saudi Arabia’s decades-long currency peg. Twelve-month forward contracts on Saudi Arabia’s riyal have plunged, a sign of confidence in the system used to keep the currency pegged to the dollar.
US policy makers are projecting a steep rise in interest rates in coming months, and Fed Chair Jerome Powell on Wednesday held out the possibility of another jumbo three-quarter percentage point increase in July.
But Saudi Arabia’s inflation outlook is favorable enough that it may not need to move in lockstep with the Fed, especially now that its real rates turned positive.
“The fact Saudi Arabia is there — or closer to being there — sooner than other countries is likely a factor in the Saudi Central Bank not mirroring the Fed in full,” said Livermore. “It is unusual but not unheard of for central banks in the Gulf not to match one-for-one the moves by the Fed.”