Bank Negara Malaysia (BNM) decided to keep the Overnight Policy Rate at 3.25% this time round after increasing it by 25 basis points (bps) during the previous meeting. Key economies, especially the USA continues to show improvement to the advantage of exporters. Domestically on the other hand, there is some wariness, especially on the consumption side. Nevertheless, we still believe that they will increase the OPR by another 25 bps, in order to get ahead of the curve before the implementation of the GST next year and that the reason they didn’t do so this time round is to give the economy some breathing space after the last rate hike.

- The BNM Monetary Policy Committee (MPC) has decided to keep the Overnight Policy Rate at 3.25% following a 25 bps raise in the previous meeting. Though their outlook of the global economy remains somewhat moderate, key economies such as the USA has been showing signs of continued economic improvement, to the advantage of Malaysia’s export sectors, though the pace is expected to be more moderate on account of a higher base effect. They did however note that domestic consumption is expected to remain modest moving forward. For now, the current OPR rate is supportive of the economy but they did mention “further adjustment to the degree of monetary accommodation may be taken” which we believe is a sign that another 25 bps hike is in the making.

- Based on past actions of BNM, a 25 bps hike was almost always followed by another hike within 6 months as we believe a mere one-off 25 bps would be insufficient to have a meaningful impact to deal with any financial imbalances. We reckon that they are allowing the economy some breathing space before taking any action. Similarly, it was probably wise of them to wait until after the Budget is announced in October, of which will come hand in hand with promises of some financial aid, to lessen any negative impact on consumers moving forward, especially when they will be facing the uncertainties of the implementation of the GST.

- Though inflation rate has been normalizing lately and expected to remain so for the rest of the year, BNM projects that it will tick up higher next year, on account of the GST. We also believe that there will be another round of subsidy rationalization and fiscal consolidation if the government wants to commit to achieving their deficit target of 3.0% in 2015 and reduce public debt, which has been skimming the self-imposed ceiling of 55% of GDP. This is also another reason why we feel that it is imperative that BNM gets on with it and raises the OPR by another 25 bps, taming inflationary pressures earlier.

- Meanwhile, capital flows into the financial market remain steady, especially following the better than expected growth in the 2Q14. Similarly, the ringgit gained strength but these have been wavering of late. However, this is more due to the attraction of a recovering US economy than a weakness in Malaysia’s. Nevertheless, rate differential and a steady economy will continue to entice foreigners to Malaysia’s shores. However, the ringgit has weakened and is currently trading around 3.24 against the dollar. It reached a 7-month high of 3.15 on Aug 27 following BNM’s first rate hike in 36 months on July 10.

- In other parts of the world, the US Federal Reserve has announced that they will be ending its stimulus programme in October. It now remains in the air as to when they will increase the interest rates. Its chairman, Janet Yellen, has so far kept mum on the issue though has given indication that if the chief part of the US economy continues to perform as it does, we may be seeing a rate hike earlier than expected. Conversely, if labour market doesn’t show sign on sustainable improvement, we may very well be seeing historically low rates for some time yet. Though we are looking at the possibility of a rate hike by the 2H15, that is still very much dependant on their labour market conditions, which face overwhelming difficulty in keeping in pace with other parts of the economy. Labour participation rate fell to 62.8% (still at 30-year lows) and job creation fell to an 8-month low of 6.1%.

- Across the Atlantic, the European Central Bank (ECB) has had to cut the interest rate again, now down to 0.05%. The central bank also cut its deposit rate, to minus 0.2% from minus 0.1%. They have also announced a stimulus programme, which will buy debt products from bank. All these measure are in hopes to derail the threat of deflation. The Eurozone inflation rate is currently at a pathetic 0.4%, lowest level since 2009. That being said, there are some small signs of improvement. Trade surplus in July rose on a 3.0% increase in exports and car sales registered a 6.0% increase for the first eight months of the year, a positive start to the 3Q14.

- Here in Asia, China has been said to inject 500b yuan (US$81b) as well as providing a $100b low-interest loans over three months into their biggest banks to counter moderating growth within the economy. Whilst in Japan, Abe may reconsider on whether to proceed with a hike in Japan’s sales tax to 10.0% after facing some severe backlash from the tax hike in April, which led to the GDP shrinking by 7.1% on an annualized rate. Similarly, the BoJ may add further stimulus to boost the economy and head towards their 2.0% inflation rate target in 2015.

Source: Kenanga