The UAE Central Bank cut its benchmark interest rate on Wednesday, joining the US Federal Reserve in cutting the policy rate for the first time in four years.

After hitting the pause on increasing interest rates since July last year, the Fed cut US interest rates by 50 basis points on Wednesday, at the end of its two-day Federal Open Market Committee (FOMC) meeting. The FOMC reduced its benchmark lending rate to 4.75 - 5.00 per cent.

With the much-anticipated cut in the benchmark interest rates, the US has entered a monetary policy easing cycle as the Fed tries to stave off a recession and achieve a soft landing for the world’s biggest economy. The Fed kept the rates at the highest level in 23 years for more than a year to combat inflation, but the move also cooled economic growth.

Most central banks in the GCC follow the Fed's policy rate moves due to their currencies being pegged to the US dollar, with Kuwait the only exception in the six-member economic bloc as its dinar is linked to a basket of currencies.

The UAE Central Bank reduced its base rate for the overnight deposit facility by 50 basis points to 4.90 per cent, effective from Thursday.

It maintained the interest rate applicable to borrowing short-term liquidity from the regulator at 50 basis points above the base rate for all standing credit facilities, the regulator said on Wednesday.

The base rate, which is anchored to the Fed's interest on reserve balances (IORB), signals the general stance of the Central Bank's monetary policy and provides an effective interest rate floor for overnight money market rates.

“The choice to reduce rates by 50 basis points – as opposed to a more tentative 25 bps cut – shows the FOMC are taking an aggressive approach to stimulating growth and propping up the jobs market,” said Mahmoud Alkudsi, senior market analyst at Abu Dhabi-based international securities brokerage ADSS.

“While interest rate cuts were largely priced in by markets, cuts of this extent come as somewhat of a surprise. The lower central rates will likely dampen an already sluggish US dollar in the short term.”

The UAE economy, which has maintained a robust growth momentum since 2022, grew by 3.4 per cent in the first quarter of this year. The country’s real gross domestic product reached Dh430 billion ($117 billion) during the January to March period, the Ministry of Economy said earlier this month, citing preliminary estimates from the Federal Competitiveness and Statistics Centre.

A 4 per cent year-on-year rise during the quarter in the non-oil sector of the Arab world's second-largest economy drove growth as the Emirates continued its economic diversification strategy.

Business activity in the UAE's non-oil private sector also maintained growth momentum in August. The seasonally adjusted S&P Global purchasing managers’ index reading increased to 54.2 in August, from 53.7 in July, well above the neutral 50 mark that separates economic growth from contraction.

The UAE's economy rose by 3.6 per cent last year, driven by a 6.2 percent boost from the non-oil sector. It is projected to grow by 3.9 per cent this year and accelerate to 6.2 percent expansion next year, with oil production forecast to increase significantly as Opec eases cuts, while the non-oil sector continues to grow, the Central Bank said.

The banking regulator projects inflation in the UAE to rise to 2.3 per cent, compared to 1.6 per cent last year, due to a moderate increase in commodity prices, wages and rents. It expects consumer prices to average 2.3 per cent in 2025 as well.

Global inflation is forecast to decline steadily, to 5.9 per cent in 2024 and 4.5 per cent in 2025, after hitting 6.8 per cent last year, according to estimates by the International Monetary Fund.

Inflation in the US has come down to 2.4 per cent in August, close to the 2 per cent desired level of the Fed, which had started the rate increase cycle in March 2022 to combat prices that hit a four-decade high of 9.1 per cent in June 2022.

The high interest rate environment aimed at cooling both inflation and job growth has stoked fears of a recession. JP Morgan Chase, the biggest US lender, in August, raised the probability of a US and global recession materialising before end-2024 to 35 per cent. It kept the probability of a recession happening by the end of next year unchanged at 45 per cent.