RIYADH, 28 March 2005 — The US Fed raised its key interest rate 25 bps as was almost universally expected by markets. In view of this near-certain possibility, markets had geared themselves up to see if the Fed would remove the phrase “measured pace” from its official statement, thus indicating faster interest rate hikes down the road.
In the event, the Fed did not, but it changed its statement sufficiently to allow a more flexible response. The Fed statement said, “Output evidently continues to grow at a solid pace despite the rise in energy prices, and labor market conditions continue to improve gradually. Though longer-term inflation expectations remain well contained, pressures on inflation have picked up in recent months and pricing power is more evident. The rise in energy prices, however, has not notably fed through to core consumer prices... With underlying inflation expected to be contained, the committee believes that policy accommodation can be removed at a pace that is likely to be measured.
Nonetheless, the Fed committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.” Although, markets had expected the rate outcome, it went on to react as if it didn’t, following the Fed announcement. Inflation fears caused US equity markets to drop to levels last seen over three months ago. Record-high oil prices have now become the “flavor of the month” to watch. Markets will be watching closely the inflation numbers ahead. The latest PPI and CPI figures, both higher than expected, show that the inflation impact of high oil prices on core inflation is just beginning and high oil price is beginning to slow down the Chinese juggernaut.
Domestically, the unstoppable Saudi stock machine continues to soar to new heights. Year-to-date, its rise is even higher than that of last year, when we were already well into the midst of a two-year rally, and many of us were warning of a correction. Such warnings have fallen by the wayside and declined in numbers in recent months, as the Saudi stock index reaches new highs on a weekly (even daily basis).
Year-to-date, the Saudi share index is up 26.5 percent compared to 11.6 percent during the same period one year ago! Meanwhile, in a new development, Saudi Arabian Monetary Agency (SAMA) data show that personal remittances by Saudis have almost doubled from SR20 billion in 2003 to SR36 billion in 2004, while those by non-Saudis dropped from SR38 billion to SR36 billion.
(Khan H. Zahid is chief economist and vice president at Riyad Bank. He is based in Riyadh.)
