By cutting US interest rates so aggressively only a week before a scheduled rate-setting meeting, the Federal Reserve has sent a strong signal of how worried it is about a recession.
The US economy is forecast to grow by just 1.2 per cent in 2008. Inflation, at 4.1 per cent, is at a 17-year high. A prolonged, albeit mild, recession in the US is now expected.
The Gulf is moving in the opposite direction. In the GCC, growth for 2008 is expected to range from 3.5 per cent in Oman to 13 per cent in Qatar.
Even before the latest rate cuts, inflation was hitting record levels. By following the US and cutting their own interest rates, GCC states will encourage more people to spend rather than save, pushing inflation higher. Already, workers are factoring in sustained high inflation in their wage demands. And it is almost certain that all GCC states will have to follow further cuts in US rates.
The expectation that the region will fall back into sync with the US if it waits long enough is fatally flawed. On current trends, such an approach will only lead to longer periods of higher inflation.
All this has a huge impact on business as inflation eats into profits, while a fear of further loan defaults in the US is pushing up the cost of lending between banks.
The shortcomings of local currency pegs to the dollar are evident to all, and the clamour for a revaluation is reaching fever-pitch. The only thing that has prevented traders taking massive bets on a GCC-wide currency revaluation this time is that they have been losing so much money elsewhere, they have been too risk averse to chance it. This will relieve policy-makers, but does not excuse inaction.
Qatar says it will issue government bonds to soak up excess liquidity and dampen inflation. But such moves are not sufficient. The rhetoric about inflation desperately needs to be replaced with far tougher action before its effects get even worse.