OVERVIEW

In June, the Consumer Price Index (CPI) growth held steady at 2.0% YoY, mirroring the rate observed in May and marginally undershooting market expectations of 2.2% YoY. Core inflation also remained unchanged at 1.9% YoY in June. Going forward, the upside risk to inflation is contingent upon the degree of spillover from additional domestic policy measures on subsidies and price controls, as well as fluctuations in global commodity prices and financial market dynamics. For the full year, headline inflation is projected to average between 2.0%-3.5% YoY, while core inflation is anticipated to remain within the 2.0%-3.0% YoY range. The May monetary policy statement highlighted that these projections have already accounted for potential impacts from subsidy rationalisation. Despite these factors, we maintain our forecast that Bank Negara Malaysia (BNM) will hold the Overnight Policy Rate (OPR) steady at 3% through 2024.

Restaurant & accommodation services costs led the growth in inflation

In June, the CPI growth remained steady at 2.0% YoY, mirroring the rate observed in May. This stability was underpinned by increases in key sectors: restaurant and accommodation services surged by 3.3% YoY (May: 3.2% YoY), food and beverages saw a rise to 2.0% YoY (May: 1.8% YoY), and education costs climbed to 1.7% YoY (May: 1.5% YoY). Transport inflation also edged higher, reaching 1.2% YoY in June from 0.9% YoY in May. A major contributing factor was the 3% increase in the average price of unleaded petrol RON97, which rose to RM3.47/litre from RM3.37/ litre in June last year, driven by a 10.2% rise in Brent crude oil prices to US$82.56/barrel. Additionally, diesel prices in Peninsular Malaysia saw a significant hike, reaching RM2.99/litre (June 2023: RM2.15/litre), with a new retail price of RM3.35/litre effective 10th June 2024. However, diesel prices in Sabah, Sarawak, and Wilayah Persekutuan Labuan remained unchanged at RM2.15/litre.

The inflation rate in June 2024 was tempered by the stability of administered prices, contributing to a more moderate inflationary environment. Key administered items such as unleaded petrol RON95 and toll charges remained unchanged YoY, providing a buffer against broader inflationary pressures.

Core inflation, which excludes volatile fresh food prices and administered prices set by the government, increased by 1.9% YoY in June, maintaining the same rate since April. This consistent uptick was primarily driven by a 3.3% YoY rise in restaurant and accommodation services, reflecting heightened demand and cost pressures in this sector. Excluding fuel prices (RON95, RON97, and diesel), the overall inflation rate climbed to 2.0% YoY in June.

In June, only four states recorded CPI readings surpassing the national average of 2.0% YoY, namely Pulau Pinang (3.3%), Pahang (2.7%), Sarawak (2.7%) and Selangor (2.4%). Elevated costs in food and beverages persisted as significant factors in these states—Selangor saw an increase of 3.3%, followed by Pulau Pinang at 2.9%, Perlis at 2.1%. In contrast, other states experienced increases below the national average inflation rate for food and beverages of 2% YoY in June.

Weathering Malaysia’s inflation tightrope

In the latest Monetary Policy Statement (MPS), BNM highlighted an expected upward trend in inflation for 2H24, driven primarily by the recent rationalization of diesel subsidies. This contrasts with the previous statement in May, which anticipated moderate inflation for 2024, underpinned by stable demand conditions and contained cost pressures. Despite the projected rise, inflation is expected to remain manageable due to mitigation measures aimed at minimizing cost impacts on businesses. Going forward, the upside risk to inflation will hinge on the extent of spillover effects from further domestic policy measures on subsidies and price controls, as well as global commodity prices and financial market developments. For the entire year, headline and core inflation are forecasted to average within the earlier projected ranges of 2.0%- 3.5% and 2.0%-3.0%, respectively. The May statement noted that these forecasts already consider the potential impacts of subsidy rationalisation.

Since the commencement of the diesel subsidy rationalization program on June 10, the price of diesel has remained at RM3.35 per litre. Given diesel's relatively low weight of 0.2% in the overall headline CPI, the potential for significant inflationary effects is minimal. Our calculations indicate that a 1% increase in diesel prices would result in a mere 0.002% rise in the overall inflation rate. Consequently, floating the diesel price from RM2.15 to RM3.35, representing a 55.8% increase, would contribute approximately 0.112% to the overall inflation rate.

In light of renewed fiscal discipline, the potential introduction of targeted subsidies for RON95 in 2H24 remains under review and uncertain. Concurrently, the substantial increase in civil servant salaries by over 13%, amounting to approximately RM10bn, poses challenges to fiscal targets and could exacerbate inflationary pressures by elevating wage expectations in the private sector. Additionally, the rollout of EPF Account 3, injecting around RM30bn into consumer spending, aims to counteract sluggish global growth and rising living costs post-subsidy rationalization, though it may also induce demand-pull inflationary pressures. We maintain our in-house headline inflation projection at 3% YoY, with risks skewed towards the lower end of the official 2.0%-3.5% range, contingent on the timing of RON95 subsidy rationalization. Nonetheless, delaying these reforms until late 2024 remains a viable option, with further details expected during the Budget 2025 presentation. A gradual approach to subsidy reform is crucial to prevent abrupt inflationary shocks.

A neutral tone in the latest MPS and the depth of ongoing risks reinforce our view that the Overnight Policy Rate (OPR) will remain at 3.00% for the rest of 2024. BNM's consistent forward guidance since September 2023 indicates a level of comfort with the current monetary settings, suggesting no immediate need for policy adjustments. Additionally, government initiatives are anticipated to continue supporting the MYR towards the year-end. We forecast the ringgit to range within the 4.55-4.65 range by year-end, considering the US Federal Reserve's (FFR) widely anticipated rate cut cycle commencing in September, despite a slower pace of US FFR cuts than initially expected earlier this year.

Source: PublicInvest Research - 25 Jul 2024