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Merrill Lynch & Company said the US has effectively given Gulf Arab oil producers the go ahead for making changes to their dollar-pegged foreign exchange policies, by recognising inflation as a problem.

In a report entitled 'US Green Light for the GCC', the US investment bank said the UAE and Qatar will probably move to a currency basket in the next few months, with their respective currencies appreciating 5% before the end of the year.

Saudi Arabia is unlikely to follow until late next year, Merrill said in the report received on Sunday.

Citing US Treasury report to Congress that for the first time mentioned currency and inflation issues in the six-member GCC, Merrill said US government had become more confident about the outlook for the dollar and therefore did not necessarily need Gulf support for its currency.

"We believe the inclusion effectively gives the GCC countries the green light for change," the bank said.

Investors piled into Gulf currencies from September on speculation some of the states in the world's biggest oil-exporting region would sever their links to a dollar that was tumbling to record lows against the euro.

While there may some domestic political constraints for currency change, ultimately a "number of GCC countries will be forced by the market to let their currencies strengthen," Merrill said.

Inflation in Saudi Arabia, the world's biggest oil exporter, rose to 10.5% in April, its highest in at least 27 years.

"At this stage, we believe that there is little benefit for the authorities to maintain normal undervaluation in the face of rising costs to the pegged exchange rate regime," the investment bank said. (Reuters)