Will inflation levels ease next year?

For 2007 Standard Chartered reckons inflation will drop to 9.6% in the UAE thanks mainly to an overall five per cent fall in rents next year on the back of an increase in housing supply as major development projects are finished.

It is the same story for the other high inflation Gulf State, Qatar where inflation of 12% this year will fall to 7% in 2007. Standard Chartered's excellent study is published on the 'SCB Economic Update' on this website, and isolates three major factors behind the high levels of inflation in the UAE and Qatar.

First, surging rental prices due to a shortage of accommodation: Abu Dhabi has been a hot-spot this year with rents up 36.6%, according to the Bank and by 50% says the local chamber of commerce. Indeed, on the chamber's forecast then inflation for 2006 in the UAE would be 16.9% and not 13.8%.

Secondly, high liquidity from high oil prices is funding high levels of government spending forcing general price levels higher. And thirdly, the devaluation of the US dollar is importing inflation in the form of more highly priced goods particularly from Europe.

Standard Chartered Bank's study points to rental prices as the key area that must be addressed to control inflation. But the authors concede that the problem here is a supply bottleneck which will only be solved as the huge amount of new property under construction reaches the market.

There is also the likelihood of a weakness in oil prices as the giant US economy tips into recession, albeit with a geopolitical price spike still possible before such weakness. This would dampen but not remove liquidity which is very strong after a quadrupling of the oil price over the past four years.

Another moot point is the direction of the US dollar. If the economy goes into recession then an asset sell-off could produce a rally in the US dollar. Predicting currency movements is very hard at the best of times but a stronger dollar would cut the cost of European imports to the Middle East.

It should be noted, however that high levels of inflation are only a problem for the UAE, Qatar and Iran. Elsewhere the Standard Chartered study detected much less variance from official figures.

This reflects the concentration of development activity in these two small Gulf States during this oil price boom and domestic economic policies particular to Iran.