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What will higher interest rates mean for the GCC?

Alan Greenspan's historic decision last week to raise US interest rates for the first time in four years brings an era of exceptionally low interest rates to an end. For rates will now also go up in the GCC.

The currency links between the GCC and the US mean that the monetary policy of this trade bloc is essentially decided in Washington.

So when the US Federal Reserve moves on interest rates, the GCC Central Banks will only be a month or so behind. Now the increase from 1% to 1.25% last week in US rates is clearly not very significant in itself, far more important is the question: how high will interest rates go?

History offers a few interesting indicators. Over the past 20 years each successive interest rate cycle has peaked at a lower level. However, with US inflation now at 2.5% compared with a forecast 1.5%, there is no room for complacency. Interest rates will have to rise further.

Economists are predicting a very gradual rise from here, with no more than a total of 1% extra by the end of the year. The problem is after that. With the US Presidential Election over the imbalances in the US economy will cry out for higher interest rates, and then 5% plus is not unimaginable, indeed past precedent would suggest that is where we are heading.

Such interest rates would probably cause a crash in global equity markets, a fall in real estate prices and an economic recession. That is how economic imbalances are corrected; long periods of cheap money just make them worse and worse.

So how would such a scenario affect the oil-rich GCC States? The first impact would be a sharp easing in demand for oil as global economies slowed down, SUVs stayed in the garage and China found its exports less easy to sell.

The knock-on effect would be lower oil prices, and thus lower oil revenues for the GCC States, albeit with some time-lag. Higher interest rates would also have some effect on GCC consumer spending, particularly cars and big ticket items financed by personal loans.

In the real estate sector, new sales would slow, and developers begin to delay new projects. Tourism would also feel the impact of impecunious western customers, although the GCC remains highly competitive in this market and other destinations would suffer more.

If this sounds like an end to the present oil boom, it could certainly mark a pause, or even a setback. However, the demand for oil from the developing Asian economies, particularly China, is such that oil prices could be expected to very quickly resume their upward march, and that will underpin the long-term economic health of the GCC.

It could be that a permanent shift in the balance of trade will take place, with the uncompetitive USA and Europe as the losers, and China and the GCC gaining. Looking at such factors as the cost of labour, it is not hard to see why such a shift should take place.

What do you think? Leave a comment below.

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