In line with our expectations, Bank Negara Malaysia (BNM) lifted the overnight policy rate (OPR) by 25 basis points (bps) to 3.25%. The decision to raise rates was supported by the improving macro fundamentals. Underpinned by a tightening monetary policy, we expect the Malaysian ringgit (MYR) to continue exhibiting a strong momentum against the USD. Room for the local currency to reach 3.90 against the USD and potentially around 3.86–3.88 in the near term cannot be ruled out. In part, this is also due to some weakening exhibited by the USD which plummeted to below 90 for the first time since 2014 due to the current policy favouring a weaker currency. Also the firm oil prices should support the USD/MYR.

While our base case for the USD/MYR is 3.90 at end-period with the average hovering around 3.93–3.95, there is room for the MYR to muscle through our base case fair value to reach 3.76 with an average of 3.80–3.82, which is our best case. Much will be supported by both the global and domestic activities. Another rate hike in 2018 is still on the table as we feel the current firm growth path allows for it. Besides, we believe the normalization rate for the OPR should be around 3.50%.

Impact on banks’ earnings following the 25bps rate hike suggests we could expect the banks’ net profit to increase by 0.9% to 2.4%. (See Exhibit 1). Given the positive impact on the banking sector, we remain OVERWEIGHT on the sector with an expected improvement in the sector's earnings in 2018 compared to 2017. This will be underpinned by higher non-interest income from stronger capital market activities as well as an improvement in net interest income from a modest loan growth of 5.0% and marginally higher NIM.

• In line with our expectation, Bank Negara Malaysia (BNM) lifted the overnight policy rate (OPR) by 25 basis points (bps) to 3.25%. The rate hike by 25bps puts BNM on the pole position to institute a tightening monetary policy amongst the ASEAN-5 countries.

• The BNM’s statement was hawkish on the current state of the economy, citing a strong growth momentum envisaged in 2018 supported by stronger global growth and positive spillovers from the external sector to the domestic economy. In addition, BNM is expecting inflationary pressure to ease in 2018, underpinned by stronger ringgit which will mitigate import cost.

• The decision to raise rates was warranted by the current macro fundamentals supported by strong exports which grew on average by 20.7% y/y from January to November 2017, added with healthy domestic activities reflected by the improving velocity and liquidity that saw consumer spending grow 6.9% y/y on average for the first three quarters of 2017.

• Besides, the domestic economy has been in negative real interest rates in 2017. In addition, the firm ringgit is reflected by the boost in the oil price and the foreign inflow into our local bourse. YTD, we noticed a net foreign inflow of around RM3.1bil which makes up about 28.7% of the total net inflow of 2017 of RM10.8bil.

• Also the 5-year credit default swap (CDS) spread, which reflects the default risk, is currently hovering at a range of 51.1 – 54.9, suggesting that the risk aversion is weak. Furthermore, we found the foreign currency holding as a percentage of total deposits has eased to 6.9% in November 2017 from its peak of 8.0% in January 2017.

• Underpinned by a tightening monetary policy, we expect the Malaysian ringgit (MYR) to continue exhibiting a strong momentum against the USD. Room for the local currency to reach 3.90 against the USD and potentially around 3.86- 3.88 in the near term cannot be ruled out. In part, this is also due to some weakening exhibited by the USD which plummeted to below 90, for the first time since 2014 due to the current policy favouring a weaker currency. Also the firm oil prices should support the USD/MYR.

• While our base case for the USD/MYR is 3.90 at end-period with the average hovering around 3.93–3.95, there is room for the MYR to muscle through our base case fair value to reach 3.76 with an average of 3.80–3.82, which is our best case. Much will be supported by both the global and domestic activities.

• Another rate hike in 2018 is still on the table. A key point highlighted in the MPC is that the economy is on a firm growth path and hence the need to normalise the current monetary accommodation. At the current level of the OPR, the stance of monetary policy remains accommodative. We believe the normalisation rate is around 3.50%.

• Impact on banks’ earnings following a 25bps rate hike suggests we could expect the banks’ net profit to increase by 0.9% to 2.4%. (See Exhibit 1). Given the positive impact on the banking sector, we remain OVERWEIGHT on the sector with an expected improvement in the sector's earnings in 2018 compared to 2017. This will be underpinned by higher non-interest income from stronger capital market activities as well as an improvement in net interest income from a modest loan growth of 5.0% and marginally higher NIM.

Source: AmInvest Research - 26 Jan 2018