The US Treasury's latest global currency outlook has for the first time examined the GCC, providing evidence that the US is comfortable with a dollar depeg, according to Merrill Lynch.

The Treasury's May 2008 manipulation report featured the GCC currencies in the summary for the first time in recent history, and expanded the section in the body of the text to explore the appreciation forces on the region's pegged currencies.

Merrill Lynch said the Treasury's new focus on the GCC had implications for the region's interest-rate management, with a specific aside to Saudi Arabia that inaction on exchange rates would compound the issue of rising inflation.

"The US Treasury's manipulation report has signalled a new phase of bringing the GCC currencies toward flexibility. We believe the addition of the GCC to the summary and expanded section in the report shows the US is comfortable with the US dollar effect of GCC forex regime change. We believe this gives an implicit US green light for change," the report said.

There had been market concerns that the US was reluctant to push the GCC countries into a change in currency regime given the possible negative effects on the dollar. The US Treasury's report suggests that those risks have lessened, according to Merrill Lynch.

The report said: "The sharp acceleration in inflation is the main source of currency appreciation pressures. As stressed in the Treasury report, some adjustment to real effective exchange rates in the region – especially in the UAE and Qatar – is taking place through rising prices. The root causes of inflation in the GCC are multiple, including higher food prices, strong demand pressures and abundant domestic liquidity.

"The US Treasury specifically focuses on Saudi Arabia, and stresses that inflationary pressures have risen dramatically over the past two years. However, the report also notes that the real effective exchange rate continues to be relatively weak in Saudi Arabia, despite the rise in inflation. This suggests the Treasury thinks that inflationary pressures will likely persist in Saudi Arabia in the absence of an exchange rate adjustment," the report added.

Merrill Lynch predicts that the GCC currencies will remain under severe appreciation pressure and the UAE and the Qatar will move to a currency basket in the next few months.

"We do not envisage a move in Saudi Arabia until late 2009, as political resistance seems to be more significant in this country," the report added.

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