Monetary policy in the GCC countries will mimic the Fed movements, while in Israel it will remain very accommodating
GCC: Moderately rising inflation
Average annual inflation in the GCC region fell from 2.7% in the period 2013-2016 to just 0.8% in 2017, mainly as a result of lower food prices and the fading of upward price pressures from energy subsidy cuts implemented in 2016. Saudi Arabia and Qatar even experienced several months of deflation.
The deflationary pressures already began to recede in late 2017 and we expect inflation to pick up across the region in 2018. The increase in average annual inflation will be highest in Saudi Arabia (4% forecast in 2018) and the UAE (3.5%) as these two countries implemented a 5% VAT at the beginning of this year.
The other four countries of the GCC originally planned to introduce a VAT in early 2018 as well but have postponed it—perhaps until 2019—in part due to worries about the impact on inflation and living standards. We forecast average annual inflation of 2.8% in Bahrain and about 2.2% in Qatar, Kuwait and Oman.
Monetary policy in the six GCC countries follows closely the interest rate movements of the U.S. Federal Reserve since all except Kuwait have pegged their currencies to the USD. And the Kuwaiti KWD is pegged to a basket of currencies that is assumed to be dominated by the USD.
Saudi Arabia, the UAE, Qatar and Bahrain have raised rates five times along with the Fed since it started tightening in December 2015. Kuwait has followed the first three Fed hikes but paused at the last two increases. Oman’s policy rate is derived from the LIBOR plus a spread (currently 50bp but adaptable if deemed appropriate), thus reflecting the Fed’s changes. We currently expect three Fed rate hikes in 2018 and the policy rates in the GCC countries should broadly continue to follow.
Israel: Inflation to remain subdued
Consumer price inflation exited deflationary territory for most of 2017 but has remained muted. It fell back to just 0.1% in January 2018. Looking ahead, rising global energy prices feeding through to transport and utility prices as well as somewhat higher food and housing costs should put upward pressure on consumer prices in 2018, but new government subsidies and a further currency appreciation are likely to offset this in part.
Overall, we forecast a modest increase of average annual inflation to 0.6% in 2018 from 0.2% in 2017, still well below the central bank’s inflation target range of 1% to 3%. As a consequence, we expect monetary policy to remain very accommodating in Israel throughout 2018, with no change to the key policy interest rate which has been at 0.10% since March 2015.
Chart 1 Consumer price inflation in selected GCC economies (%y/y)
Chart 2 Consumer price inflation and monetary policy rate in Israel