Expensive dollar funding kept United Arab Emirates one-year currency forwards near a 15-month low on Thursday, implying a stronger currency, while UAE interbank benchmark rates stayed at seven-year lows.

One-year dirham forwards were quoted at -22/-12 points  on Thursday, after they dipped to the low of -30 points bid on Tuesday as local banks rushed to the forex swap market to get dollars, dealers said.

'There is no dollar liquidity in the market. Lending through the interbank market has become very expensive,' said Lyndon Loos, head of forex trading for Middle East and North Africa at Standard Chartered in Dubai.

'They (banks) are looking through other avenues to generate cheap dollar funding. The most used channel is the FX swap market,' he said.

Forwards now imply traders' bets that the dirham will firm by 0.1 per cent against its 3.6725 peg to the dollar over a one-year period.

'People have been selling their local currencies to buy dollars, the expensive dollar funding gets reflected through the swaps,' a trader at a UAE bank said.

'It is the demand for dollars, because Europe has a bit of a meltdown, a bit of a credit crunch... It's all drying up, the local banks just don't lend dollars or euros to each other.

Saudi Arabia's one-year forwards, among the most liquid in the Gulf, held around -48/-40 points on Thursday, after touching seven-month lows of -62 points on Tuesday.

Global markets have been in turmoil for the past month, weighing another possible US recession and the impact of the euro zone debt crisis on the world economy.

The dollar held steady against the yen on Thursday, clinging to gains made the previous day on short-covering as investors fretted that the US Federal Reserve may not signal new stimulus for the economy this week.

The UAE, which pegs its currency to the US dollar like most Gulf Arab states except for Kuwait, said in August it would keep its peg to the greenback even after Standard & Poor's downgraded the world's biggest economy.

Gulf states are also major investors in US Treasuries.

UAE benchmark interbank offered rates have stabilised over the past few days as liquidity in the market stayed high, traders said.

The benchmark UAE three-month interbank offered rate was set at 1.473 per cent at Thursday's fixing for the eleventh consecutive day, the lowest level since June 2004. The rate remains however well above the Saudi benchmark of 0.600 per cent.

'It will be stable for the moment, even if it has to go down, maybe a maximum of around 0.5 to 1 basis point move,' another trader said. 'I feel it has bottomed out.'

After Dubai's debt crisis in November 2009, the rate climbed to a peak of 2.4 per cent in July 2010.

Deposits at UAE banks stood at Dh1.126 trillion ($307 billion) in June, up 0.2 per cent from the previous month and 7.3 per cent from December, when the Arab world began to slip into turmoil. However, bank lending is still sluggish following Dubai's debt woes and weakness in the property sector. – Reuters