Cost of Transport Improved Sharply Due to High Base Effect

Malaysia’s headline inflation slowed to 2.7% yoy in January, improving sharply from 3.5% in December. This was also slightly better-than-market expectations of 2.8%, due mainly to the sharp improvement in cost of transport. Prices of food and non-alcoholic beverages also slowed from 4.1% yoy in December to 3.8% in January. The underlying core inflation, which exclude volatile and administered price items, remained unchanged at 2.2% yoy for the third straight months since November 2017, signalling that the country’s inflationary price pressure remained stable. Cost of transport improved sharply from 11.5% yoy in December to 5.7% in January, the first single digit growth in 12 months. This was due partly to high base effect in the corresponding period of last year as domestic retail petrol prices (i.e. the more commonly used domestic RON95 petrol price) rose marginally to an average of RM2.28 per litre in January as compared to RM2.27 per litre in December. Petrol (RON95 & RON 97) and diesel contribute a weight of about 8.5% in the total consumer price index (CPI) basket. Going forward, we believe the country’s cost of transport will remain manageable as reflected in steadier global oil prices (as benchmarked by Mean of Platts Singapore price) and possibly stronger Ringgit against US$. However, in February, prices of food & non-alcoholic beverages, the largest component in the CPI basket with a weight of 29.5%, may trend higher partly due to Lunar New Year festive season. With producer price index (PPI), which measures inflation at the producer/manufacturer level, declining by 1.2% yoy in January (0.3% in December), we expect cost-push inflation to remain manageable in the months ahead. For 2018 as a whole, we are maintaining our inflation forecast averaging around 3.0% level, as compared to 3.7% in 2017 (2.1% in 2016), partly due to a stronger ringgit exchange rate and lower import costs.

Changes in the Weightage of Components in the CPI Basket

Effective January 2018, Department of Statistics (DOS) will be using the new basket of goods and services to calculate Malaysia’s Consumer Price Index (CPI) based on the pattern of expenditure obtained from the Household Expenditure Survey (HES) 2016, which was conducted from April 2016 to March 2017. In the new CPI basket, there were 22 items being added, while 2 items were removed, bringing the total to 552 items.

The share of expenditure on food and non-alcoholic beverages fell below 30% level, from 30.2% from the previous weightage based on HES 2014 to 29.5% based on HES 2016, while the share of expenditure on transportation increased from 13.7% to 14.6% and the share of housing and utilities remained unchanged at 23.8%. These three main categories i.e. food, transport and housing currently constituted about 67.9% to the overall new CPI basket, see Fig 2.

Strong Growth in Domestic Demand Expected to Continue Into 2018

Bank Negara Malaysia (BNM) raised its Overnight Policy Rate (OPR) by 25bps to 3.25% in January 2018, after holding the rate steady at 3.0% since July 2016. With manageable inflation going forward, where BNM guided that inflation will likely average lower in 2018 from smaller effect from global cost factors, we expect the stance of the country’s monetary policy to be accommodative and supportive of domestic demand. International Monetary Fund (IMF) recently cautioned that while the global economy was showing broad-based growth, the landscape was shifting with heightened risks of trade disputes, monetary policy normalisation and technological change. As a result, we believe BNM will likely maintain its policy rate at 3.25% in 1H18 and wait until 2H18 to gauge the state of the Malaysian economy, before deciding on whether to raise OPR by another 25bps to 3.5% by end-2018.

Ringgit Likely to Strengthen to RM3.80/US$ Towards End 2018

The Malaysian Ringgit (RM) has appreciated steadily against the US$ since early 2H2017, following further liberalisation of the bond market and foreign exchange hedging requirements announced by the Financial Markets Committee of Bank Negara Malaysia (BNM) in 2017. Since early 2H17, the pace of ringgit appreciation against the US$ has accelerated, strengthening by 10.9% to a high of RM3.87 on 26 January 2018 (currently at RM3.92). The strengthening Ringgit against US$ reflected sound domestic economic fundamentals and expectations of monetary policy normalisation by BNM as well as inflows of non-resident portfolio supported by positive investor sentiments. According to BNM Financial Market Committee update, the conversion of forex from export proceeds to Ringgit to June 2017 was US$3.6bn from December 2016. Net export proceeds FX conversion rose to a cumulative amount of +US$7.3bn since December 2016 to Sep 2017 and US$9.2bn as at Dec 2017 (–US$0.5bn between January and November 2016), reflecting an increase of US$5.6bn from June to December 2017. With Malaysia expected to record an impressive economic growth in 2018, as well as expectations of higher oil prices and possible monetary policy normalisation in 2H18, we expect Ringgit to trade between RM3.90-3.95/US$ throughout most of 1H18 and may appreciate to RM3.80/US$ by end 2018 (from our earlier assumption of RM4.05/US$ by end-2018) due to higher net export proceeds FX conversion.

Source: Affin Hwang Research - 1 Mar 2018