Global Economy Likely to Sustain Growth Momentum in 2018

Bank Negara Malaysia (BNM) has decided to maintain its Overnight Policy Rate (OPR) at 3% at the eighth consecutive MPC meeting since July 2016. The latest policy statement, especially in the forward-looking paragraph on the global and domestic economies, reflected optimism about the economic prospects. BNM noted that the global economy continues to strengthen as “growth become more entrenched and synchronised across regions.”

Growth in the Asian region continues to be supported by both domestic activity and strong external demand. Despite cautioning on downside risks arising from geopolitical and policy developments in major economies, BNM is confident that economic prospects would remain favourable next year. As a result, BNM stated that domestic economic growth has become more entrenched, driven by the strong spillover from the external sector to the domestic economy, as firms invest in productive capacity, raise wages and hire more workers.

In 2018, domestic demand will likely remain as the key source of economic growth, particularly from private consumption. BNM expects the overall domestic economy to be supported by continued improvements in income and overall labour market conditions. Investment would also be sustained by infrastructure projects and higher capital investment in the manufacturing and services sectors, mainly driven by strong domestic and external demand.

On the inflation front, BNM explained that the recent high headline inflation at 4.3% in September, was mostly driven by higher global prices of refined oil; this, in our view, was in reference to Malaysia using MOPS95 as the benchmark for the calculation of the retail RON95 pump price. BNM noted that the inflation this year would likely be at the upper end of its forecast range of 3.0-4.0%. However, the headline inflation is expected to moderate in 2018, due to a smaller effect from global cost factors. Nevertheless, BNM acknowledged that the direction of the headline inflation would be affected by global oil prices, as expenditure on fuel carries a significant weight in the overall consumer price index basket.

Going forward, as the country’s monetary policy is “forward-looking”, with BNM guiding in the latest MPC statement that “it may consider reviewing the current degree of monetary accommodation,” we believe BNM may be providing some early indication of possible normalisation or hike in the benchmark interest rate (OPR) in 2018. We believe the rationale for the rate increase, if it materialises, would be to prevent the economy from exceeding its potential output level, which would translate into higher inflationary pressure.

We are maintaining our view that BNM will likely increase its OPR by 25 bps to 3.25% in 2H18, on expectations that the current strong economic momentum continues on a favourable global economic environment. However, we believe that any increase in the OPR in 2H18 would be at a measured pace, and the magnitude of increase would be gradual and dependent on macro growth and CPI data, following closely also the development in US monetary policy, direction of the Fed Funds rate and reduction in the Fed’s balance sheet.

Source: Affin Hwang Research - 10 Nov 2017