United Arab Emirates: 01/07/2006

US dollar devaluation, inflation and Dubai property

Last week's interest rate tightening by the US Federal Reserve means higher mortgage payments for Dubai property owners, as local monetary policy is US pegged. However, the wider forces at work in the US economy will probably have much more profound effect on Dubai real estate, and could cushion against a crash.

The US housing market is slowing down. A plethora of recent statistics have demonstrated slowing sales and regional price falls, though nothing to suggest a major market collapse.

The 25 basis point rise in US interest rates last week will hardly help to ease this growing pain. But it looks as if the tightening of US interest rates by the Federal Reserve is now coming to an end and policy watchers increasingly wonder what will happen after that.

On historical precedent the Federal Reserve will wait between three and six months before starting to cut interest rates. Typically it might take a disruption in financial markets, say in October, to provoke the Federal Reserve into action. The US dollar would then devalue which is normally a stimulus to inflation.

US exporting inflation

For the US has a habit of exporting its economic problems to other countries by the mechanism of devaluation and inflation. The alternative is a much more painful realignment of asset prices, although the US is normally trying to dampen the impact of the latter when it cuts interest rates.

So the outlook for Dubai property owners might in fact turn out to be lower interest rates in an inflationary global environment. Under those circumstances property is a useful place to have your money parked.

For one thing the cost of a mortgage falls in such a scenario while rentals will be at least maintained due to inflationary pressures. Meantime, inflation is likely to safeguard the nominal value of property even if it begins to fall in value in real terms due to oversupply.

A soft landing

This is the classic formula for a 'soft' and not a 'hard' landing for a property boom. Inflation can pad the edges for investors, and cushion them against a nasty fall in nominal values which could leave mortgagees facing a situation of negative equity, that is to say borrowings bigger than the value of their assets.

Where high inflation and US dollar devaluation does catch up with real estate investors is if they want to sell up and buy a property in a non-US dollar linked economy. Then they will find prices higher in dollar terms and their assets worth less.

However, this does also mean that the argument of waiting for a crash in Dubai property market could prove an expensive mistake. Paying out high rentals while waiting for prices to undergo a correction is going to look an error if nominal prices remain unchanged in an inflationary environment.

It could be that the Federal Reserve will take a harder line and squeeze US mortgagees with higher interest rates to choke inflation. But in democratic states voters usually only reward politicians that give them the easiest option and that fact of life will lead to the saving home owners as far as possible.