Inflation in August ticked up a bit, rising to 3.3% annually, marginally above consensus’ estimate of 3.2%. This is on account of increases in the food & beverages, transportation, and housing, electricity & fuels indices. We believe that the CPI will average at about 3.3% this year as it is pushed by higher costs for much of the year despite going about a round of normalization of late. On the back of strong growth momentum in the 1H14 with inflation remain elevated and the need to deal with the financial imbalance we believe that BNM will raise the OPR by another 25 basis points in the coming meeting. Though this will add yet another burden towards the domestic economy, doing it now will mean lesser backlash once the GST is implemented in April 2015.

- Inflation inched up a tad in the month of August, posting a 3.3% annual growth after seeing a 3.2% increase in the previous month. This is just minutely above market expectations of 3.2%. This is largely on account of a rise in prices of food & beverages, as well as a transportation and housing, electricity & fuels. The core inflation (minus food & beverages) also inched up slightly to 3.3% from 3.2%. From the period of January to August, the CPI rate averaged at 3.3% compared to 1.7% seen in the same period in 2013. On a monthly comparison, inflation rose by 0.2% MoM.

- Though the prices of food and beverages went up annually by 3.3% from 3.1%, the monthly comparison only saw a 0.1% MoM increase as there was little demand pull reason to pressures prices. There were also limited celebrations (such as open houses) despite being the month of Eid and Merdeka in mark of respect for the MH17 tragedy.

· On wider view, the global food inflation as measured by the United Nation’s Food & Agriculture Organization (FAO) fell by 3.9% and 3.6% both YoY and MoM respectively. With the exception of meat, this is due to all food sub-indices falling, lead by dairy, followed by oils and sugar.

· The housing, water, electricity, gas and other fuels index inflation increased by 3.4% due to a 0.6% MoM rise. We do not think that there is much pressure on this index and that the increase may be due to one-off factors in the month of August as a similar trend was seen in the previous year. Similarly, we believe that the impact from the electricity tariff and gas price hike earlier in the year has normalized. Due to an annual comparison as a gauge of inflation, it will be some time before we start seeing the rate closer to its long term average of 1.6% YoY.

- The transportation index rose to 5.5% from 5.4%, and saw a small 0.1% month-on-month increase. As a result of strong economic growth in the 2Q14, we may see another round of subsidy rationalization in the 2H14. This is of course subject to other circumstances such as the strength of domestic demand, which was seen tapering off due to higher costs as well as the burden of the recent increase in interest rates dampening consumption further. It is just as well that the prices of oil have been low, meaning that the government will need to fork out less to keep subsidized oil steady.

- The price of Brent in July ended the month at US$103.2 (-9.5% YoY) and U.S crude settled at US$95.9, (-10.9% YoY). Prices of Brent last settled at US$98.8/barrel and US crude at US$94.6/barrel on the 17th of September 2014. According to the International Energy Agency, prices of oil have come off due to weak demand from Europe and China. Meanwhile, OPEC may reduce supply to boost prices.

Outlook

- We see little pressure on inflation in the short term, with the exception of the year-end holidays and festivities of which we believe demand-pull inflation will be limited as consumers are faced with higher interest rates. Nevertheless we still retain our 2014 CPI to average at 3.3% due to higher inflation from earlier in the year.

- We also expect another 25 basis point hike putting the Overnight Policy Rate at 3.50% before the year-end, as strong growth in the 2Q14 adds justification for the BNM to raise rates further. However, we hope they intend to do it sooner than later so as to give some breathing space for the economy before the implementation of the GST come April 1st, 2015.

Source: Kenanga