OVERVIEW

Inflation in May moderated further to 3.2%, lower than market consensus of 3.3%. This is on account of lower core inflation and smaller increases in the prices of food & beverages. Overall inflation has been on a normalization trend, though we do expect some price pressures in conjunction of the Ramadhan and Eid period. Ceteris paribus, we reckon that CPI will average at 3.3% this year. As inflation remains cost-push and risk to growth remains on uncertainty coming from China, Japan and Europe, we retain our belief that BNM will only raise the interest rates as a last resort.

- Inflation continues to taper off, recording a 3.2% YoY growth in May following a 3.4% rise in the previous month. The market had estimated a rise of 3.3%. The slower inflation rate is due to lower food prices as well as the core inflation (minus food and beverage), which expanded at a slower pace of 3.1%. For the first five months of the year, CPI averaged at 3.4%, compared to 1.6% seen in the same period in 2013. On a monthly comparison, inflation rose by a minute 0.1% MoM.

- The prices of food and beverages increased at a more moderate pace of 3.3%, compared to 3.6% previously. On a monthly comparison it rose by 0.1% MoM. There is a possibility that prices of food & beverages will suffer from inflationary pressures due to the El Nino, which is expected to bring about another round of hot and dry weather. However, any impact ought to be mitigated by strict price controls in the country. Moving forward, we do expect a momentary uptick in this index due to the fasting month of Ramadhan and the following Eid celebrations.

- On broader scope, the global food inflation as measured by the United Nation’s Food & Agriculture Organization (FAO) saw a 0.7% MoM decline, due to lower dairy, cereal and vegetable oil prices. An annual comparison saw a 3.2% decline in food prices.

- The housing, water, electricity, gas and other fuels index inflation growth moderated to 3.1% YoY from 3.6% in April. On a monthly comparison, this index rose by 0.5% MoM. Similar to the transportation index, it will take some time (we reckon between 6 to 9 months) before this index begins to normalize after the increase in the electricity tariff and rise in natural gas prices. For now, this index will most likely continue to post above its longterm average of 1.6% YoY.

- The transportation index expanded by 5.5% YoY, from 5.3% previously. However, it only increased by 0.1% MoM, indication that prices has normalized since the petrol price hike at the end of 2013. However, there is a distinct possibility that the better-than-expected GDP growth in the 1Q14 of the year may prompt the government to consider further reduction of subsidies.

- Nonetheless, prices are still considerably higher than the long-term average, putting a strain to overall expenses and domestic demand, particularly consumer spending which was already seen moderating in the 1Q14 despite all the festivities in the earlier part of the year. Purchasing power should be allowed to recover before any further subsidy rationalization.

- On broader view, the price of Brent in May ended the month at US$109.4 (+9.0% YoY) whilst U.S crude settled at US$102.7, +11.7% higher than last year. Prices of crude have been on the rise on concerns due to supply disruptions, largely on the back of escalating violence in Iraq. U.S. crude last settled at US$107.3/barrel and Brent at US$114.8/barrel on the 20th of May 2014.

Outlook

- In the near term, there are some pressure expected from the food and beverages index, on account of the hot weather and due to the Ramadhan and Eid period. However, this is momentary and will partly be mitigated by strict price controls. Ceteris Paribus, we are looking at the overall inflation rate to be around 3.3% this year. On the fact that most of the inflationary pressures are cost-push, festivities notwithstanding, we don’t think it gives enough justification for BNM to raise in the Overnight Policy Rate from the current 3.00%. Consumer spending is still feeling the pinch of belt-tightening and there’ll be another round of penny-pinching once the GST is implemented in April 2015. Only when BNM has exhausted other tools such as macro-prudential measures will they adjust the OPR. Further more, there is still concern pertaining to growth uncertainties from China, Japan and Europe.