Stars Are Aligned For A Couple More OPR Hikes

Chart 1: Malaysia OPR (2004-1H2023)

Source: Bloomberg; BNM

The monetary tightening cycle began in May 2021, following the easing of mobility restrictions and resumption of economic activities. Going back to basics of traditional monetary policy, central banks revise interest rates to manage inflation while monitoring economic growth and employment. 

Malaysia’s inflation rate tamed by subsidies

Chart 2: Headline and core inflation rate

Source: Bloomberg

Against the backdrop of elevated global commodity prices, inflationary pressure in Malaysia is mainly caused by higher food prices. As of November 2022, core inflation – calculation excludes most volatile items of fresh foods, as well as administered prices of goods and services – tops at 4.2% (October 2022: 4.1%). Meanwhile, headline inflation is expected to close at average 3.3% in full fiscal year 2022.

While these figures were deemed under control when compared to its regional counterparts, officials acknowledge that the country is managing its inflation rate through a combination of hefty subsidies, existing price controls and spared capacity. Based on government estimates, inflation could reach 11% if subsidies were to be removed. 

While subsidy removal is a touchy subject, it leaves growing concerns on the country’s financial stability for the long run. If measures were to be removed, Malaysians will experience a double whammy of an increase in interest rate and frightening price hikes. As such, the heated topic of targeted subsidies will continue to be in the spotlight in the foreseeable future. 

We note that Post-15th General Election has cleared the clouds on the inflation outlook as the coalition government signaled their intentions to maintain subsidies. At least for 2023, we foresee that the inflation rate will soften and thus, bring down on overall inflationary pressures in the near term. 

A robust growth 

Chart 3: Malaysia's GDP growth

Source: Bloomberg 

Malaysia’s GDP growth, another key indicator of monetary stability, stood at a strong 14.2% for 3Q2022 driven by robust domestic demand. A healthier job market and better income prospects will continue to underpin household spending going forward. As of end-November 2022, Malaysia’s unemployment at lowest level in October 2022 since start of Covid pandemic, reflecting a steady recovery pace. 

In line with expectations, we believe there is a reasonable chance that BNM will raise rates on a gradual basis. We expect in 0.25 percentage point increase on each official meeting in 2023. This is also in line with our view that the current 2.75% OPR still has room to grow before reaching its neutral rate within 3.25%-3.50% range.

Despite improvements in the global supply chain, the continued adjustments particularly in US interest rates along with expectations of a higher terminal rate have caused a persistently strong US dollar environment. However, the central bank may not be adopting the hawkish stance taken by the US Federal Reserve which has since announced its 7th interest rate hike of 2022. 

According to BNM, adjustments in its monetary policy have been consistent with the domestic economic condition. Malaysia, being a small open economy, is feeling the pinch following the higher volatility in the financial market. The chart below depicts the YTD movement of other currencies against the US Dollar. 

Chart 4: Movement of selected currencies against the US Dollar (from Dec 2021 to Dec 2022)

Source: Bloomberg

As above, the Ringgit, alongside the currencies of other major trade partners have experienced significant weakening against the US Dollar. However, the Ringgit has been broadly resilient. As currency valuation is a relative measure – Ringgit depreciation is due to the US Dollar strengthening – it may not be a signifier of a weak currency and Malaysia is not in an economic crisis. 

In view of this, we also expect the local capital market to gain traction in 2023 as it provides a good alternative for currency diversification, primarily in the fixed income space. To date, Malaysia bonds are offering such attractive yields with significantly less risk than equities. Investors who are keen to take advantage of the current bond market can consider these bonds: MMCMK 5.700% 24Mar2028 Corp (MYR), YTLPMK 4.990% 24Aug2028 Corp (MYR), ECWMK 5.690% 29Oct2027 Corp (MYR), and AFFBNK 4.750% 16Dec2027 Corp (MYR). 

The rising prices within the Malaysian context are deemed manageable although coming at a large cost to the country.

The likelihood of a higher-than-expected inflation rate should be contained by the existing price controls, subsidies, and capacity in the balance of payments. However, any changes in the domestic policy measures, as well as any development in global commodity prices arising from ongoing military conflict in Ukraine and prolonged supply-related disruptions are detrimental to the local inflationary environment. 

In a nutshell, a continued, albeit low-pressure rate hike this year is appropriate control the rising cost pressures, without the risk limiting of economic growth.