Interbank offered rates in the UAE continued their slide to a fresh seven-year low on Sunday, as liquidity in the Opec member's banking sector stayed high, also dragging one-year dirham forwards lower.

Bank deposits had risen to their highest level in at least two years in April as the Gulf Arab state enjoyed a safe-haven status amid regional unrest, but dropped again slightly in May.

The benchmark three-month interbank offered rate, based on quotes from a dozen banks, was set at 1.505 per cent at Sunday's fixing, the lowest level since June 2004. Before Dubai's debt crisis in November 2009, the rate was 1.915 per cent.

The rate remains, however, well above the Saudi benchmark of 0.600 per cent.

"It is the high liquidity and the banks now falling in line with what is required by the central bank. A few of the banks who have had higher rates have now brought the rates in line with the other banks which has brought the average down," said Lyndon Loos, head of forex trading for Mena at Standard Chartered in Dubai.

"The banks are now falling in line with what is required by the central bank, which is making the three-month EIBOR come off quite considerably," he said.

In May, the central bank urged banks to bring rates down and increase lending after September's debt restructuring deal with Dubai World.

Deposits at UAE banks stood slightly lower at Dh1.124 trillion ($306 billion) in May, down 0.4 per cent from the previous month, central bank data showed.

Loans and advances increased by 2.7 per cent year-on-year at the end of May after a 3.2 per cent rise in the previous month.

However, banks are still cautious about lending following Dubai's $25 billion debt restructuring last year and a still weak property sector.

UAE private sector credit growth has been anaemic, at a mere 0.2 per cent year-on-year in April, compared with annual rates of well over 50 per cent in the oil-boom year of 2008.

The UAE pledged to spend $1.6 billion in less-developed northern emirates, introduced bread and rice subsidies and hiked military pensions among other measures.

Improved liquidity in the UAE, the second-largest Arab economy, has also helped push currency forwards down over the past five months.

"There is quite a bit of local currency liquidity available within the country which is basically keeping short-term rates lower and the forex swaps also," Loos said.

One-year dirham forwards were quoted at -6.5/0.5 points on Sunday, compared with a peak of 45 points at the beginning of March. Forwards now imply the dirham will hold close to its 3.6725 peg to the dollar over a one-year period. 

Dubai's credit default swaps, the cost of insuring the emirate's debt against default for five years, stood at 332.5 basis points on Thursday, up from 327.6 points earlier this month, according to Markit. – Reuters