Inflation in July rose by 3.2%, slightly below market consensus of 3.3%. This is due to a slight tapering in the food & beverages index. Overall inflation still remains somewhat elevated but more contained, as celebrations were scarce in respect of the MH17 tragedy. We foresee the CPI to average at 3.3% this year, higher than long-term average of 3.0% as the economy goes through a period of adjustment. Due to the better-than-expected growth in the 2Q14, there’s every possibility that BNM will raise the OPR another 25 basis points, as per their modus operandi seen in the past. This may put yet another damper on consumer spending moving forward.

- Inflation inched slightly lower in July, posting a 3.2% YoY growth after seeing a 3.3% rise in the previous month. This is slightly below market expectations for a 3.3% increase. The moderating rate is due to a slight tapering of food prices, which we believe had already peaked in the previous month. The core inflation (minus food & beverages) remained at 3.2%. For the period of January to July, the CPI averaged at 3.3% compared to 1.7% seen in the same period in 2013. On a monthly comparison, inflation increased by 0.1% MoM.

- The prices of food and beverages moderated to 3.1% from 3.5% seen previously. On a monthly comparison, it gained 0.3% MoM, a slower pace from 0.5% in June as increases remained limited despite the run up to the Eid as strict price controls remain in place. Additionally, celebrations were limited and in many circumstances, cancelled entirely in respect of the MH17 tragedy.

- On broader view, the global food inflation as measured by the United Nation’s Food & Agriculture Organization (FAO) fell by 2.1% MoM, due to sharp fall in prices of grains, oilseeds and dairy. An annual comparison saw a 1.7% YoY decline in overall prices.

- The housing, water, electricity, gas and other fuels index inflation remained steady at 3.2% YoY, and saw no monthly changes. This point to the fact that the impact from the electricity tariff and gas price hike earlier in the year has already begun to normalize. It will be some time yet before it returns to its long-term average of 1.6% YoY, as there’s every possibility of another tariff adjustment in the near future.

- The transportation index moderated slightly to 5.4% YoY from 5.5%, and saw no month-on-month changes, which mean that prices since the petrol price hike at the end of 2013 have since then normalized. Due to strong economic growth in the 2Q14, there is now an even higher possibility that we see another subsidy rationalization in the 2H14. However, the details of the growth should be examined closer and it was shown that private spending was on a moderating trend and another price hike will further cut into consumption. Consumers are now burdened with a higher interest rate (which is expected to increase further), slicing deeper into pockets. There will already be another round of belt tightening come April 2015 as the GST is implemented, diminishing purchasing power even further.

- On broader view, the price of Brent in July ended the month at US$106.0 (-1.6% YoY) and U.S crude settled at US$98.2, (-6.5% YoY). Prices of Brent last settled at US$102.3/barrel and US crude at US$96.7/barrel on the 20th of August 2014. Prices have come off as geopolitical tensions ease and less fears of limited supplies. However, those same tensions will also continue to put pressure on crude oil and gas price so long as fighting continues (and it will for a long time yet).

Outlook

- In the short term, we had initially expected pressure from the food and beverages index surrounding the festivities to put pressure on overall inflation but in light of the MH17 tragedy, we reckon that inflation will moderate even further. Moving forward, we estimate that overall inflation will be around 3.3% this year. With better-than-expected 2Q14 growth, this may give justification for BNM to increase the OPR by another 25 basis points, possibly as soon at during the September MPC meeting. At the same time, better growth could also mean justification for another round of subsidy rationalization.

- However, private consumption should be analyzed closer and it was plain as day that it has been on a moderating trend of late. Much of the economy’s growth was attributed to sublime performance in exports, while domestic demand has been moderating. Policy makers need to keep into consideration the impact of multiple price hikes, in such a short period of time, towards the everyday consumer. Any initiatives to achieve the 2020 target will be fruitless if consumers are burdened with burgeoning costs of living.

Source: Kenanga