There is room for BNM to raise rates by 25bps in the coming MPC meeting despite some views that rates will remain unchanged at 3.00% due to the stronger USD/MYR and the election factor. Fundamental factors that allow for a rate hike in our view are: (1) a prolonged period of negative interest rates; (2) a pickup in the velocity of money reflecting stronger fundamentals; and (3) healthy liquidity.

Should there be a hike in January, it will have a temporary positive impact on banks' net interest income (NII). Thus, the extent of benefits to earnings will depend on the respective banks’: i) percentage of floating rate loans; and ii) the ratio of domestic to total loans as well as the timing of the rate hike relative to the banks’ FYE.

• We expect the OPR, which is at 3.00%, will most likely be lifted by 25 basis points (bps) to 3.25% by Bank Negara Malaysia (BNM) in the coming 25 January Monetary Policy Meeting though there are views that the authorities may not raise rates owing to the strong USD/MYR which should help ease inflationary pressure via imported inflation and also the upcoming general election. • Nonetheless, the current macro fundamentals do open the door for the central bank to institute its first rate hike in 2018. The economy has been in the negative real return region for most of 2017 due to the high inflation which we project the full-year average at 4% (see Chart 1).

• We think the inflationary pressure may continue in the early months of 2018 despite the current strong USD/MYR given the oil prices are firm and also price pressure emanating from the demand side. However, the negative real returns may not rise steeply as they are partly negated by a high base, especially in the month of February to April 2017 where the average inflation is 4.7% y/y versus 3.2% in January 2017.

• Although our 2018 full-year average inflation outlook is around 2.5% - 2.8%, we believe the bulk of inflationary pressure will come from the demand pull reflected by the rising velocity of money (see Chart 2) as well as liquidity (see Chart 3) and complemented by the cost and supply side of the inflation. However, the upwards pressure will somewhat be negated by the high base.

Source: AmInvest Research - 24 Jan 2018