CBUAE has just announced a significant change in monetary policy in the United Arab Emirates, in that it reduced the base rate by 0.50 percentage points with effect from September 19. The base rate applied to ODF has been cut from 5.40% to 4.90%.

This adjustment in the base rate follows an action from the US Federal Reserve when it cut 50 basis points off its interest rate on reserve balances. The decision of the US Federal Open Market Committee in cutting the IORB is intended to influence overall economic conditions through the route of cheaper borrowing and, therefore, sparking economic activities.

Moreover, the interest rate applicable for borrowing short-term liquidity from the bank in respect of all standing credit facilities is announced at 50 basis points above the new base rate. This simply means that the cost of borrowing from the CBUAE to avail short-term liquidity will now go to 5.40%, reflecting the new base rate plus a margin of 50 bps.

Consequently, this step is more likely to highly influence the monetary environment of the country by the CBUAE. While cutting the base rate, it may lower the cost of borrowing for the banks, which, in turn, can cut the rates at which businesses and consumers can borrow. This, in turn, may further enable a rise in borrowing and spending, hence affecting the economic activity of Emirates. This adjustment also tends to bring the monetary policy of the UAE closer to that of the United States-something significant, given the fact that the dirham is pegged with the US dollar. This peg links the UAE currency movements directly with those of the US dollar, and thus, for economic stability, it becomes important that the monetary policy of the UAE should be a reflection of the changes in US monetary policy.

This interconnection of global financial systems is reflected in the decision of the bank to cut the base rate and to keep the borrowing rate at a fixed margin over this new rate. With this, economies around the world are so interlinked that actions of major central banks, such as the Federal Reserve, create ripples across global markets. Of course, a move in step with US monetary policy means that CBUAE has been taking decisions with one eye on domestic economic conditions and the other on the international economic environment.

In other words, the recent decision to cut its base rate by 50 basis points and adjust its corresponding borrowing rate of CBUAE was actually the signal of a tactical effort to manipulate the UAE's economic conditions to conform with the international financial trend. In that respect, the change is meant to have implications for both the cost of borrowing and the level of economic activity in the Emirates, as the UAE monetary policy quite clearly follows that of the United States.