OVERVIEW

As expected, consumer price inflation moderated for the fourth month to 1.6% YoY in June, compared with 2.0% in May. The headline inflation was lower than the consensus estimate of a 1.8% YoY increase but matched the house estimate. The declining transportation cost, mainly due to lower fuel price relative to last year, was the main factor behind the soft inflation rate. In addition, the lapsed impact of GST cost pass-through has helped the inflation to stay low. By category, Transport (13.7% share of CPI) fell 0.1% MoM and plunged 8.5% YoY on a high base effect. Food & Non-Alcoholic Beverages rose 0.5% MoM and 4.2% YoY before the Eid festive period. We believe inflation will remain subdued in 3Q16 before ending the year on a slightly higher note. In view of the weak domestic growth prospect and tepid consumer sentiment, we revise down our full-year inflation forecast by 0.3 percentage points to 2.3% YoY. Following the surprise 25 bps cut in the OPR in July, we expect Bank Negara Malaysia to keep the OPR at 3.00% for the remainder of the year, enabling the monetary policy transmission to work its way in the 2H16. However, if the disinflationary trend continues amidst weaker growth prospect it could give BNM more room to cut interest rates sooner than later.

The Consumer Price Index (CPI) increased 1.6% YoY in June, compared with 2.0% YoY registered in May. The CPI has been on a moderating trend for the fourth consecutive month. The headline rate was below the consensus expectation of 1.8% YoY but matched the house forecast. The CPI grew 0.2% MoM compared with 0.3% in May.

The relatively soft headline inflation in June was largely attributable to falling transportation cost. In addition, inflation in June continued to experience receding inflationary pressure thanks to the lapsed impact of Goods and Services Tax (GST) cost pass-through which provided a higher base for the index from April last year onwards when it introduced.

The year-to-date average YoY growth for CPI was 2.7% compared to 1.4% in the corresponding period a year ago. Meanwhile, core inflation stayed at 2.1% YoY in June.

The main category of Food & Non-Alcoholic Beverages with a 30.2% share of the CPI grew 0.5% MoM. The inflation in this sub-category remained on an accelerating trend following a 0.3% MoM growth in May and a no-change in April. The MoM performance of the CPI reflects the performance of United Nations Food and Agriculture Organisation’s (FAO) Food Price index which jumped to 4.2% MoM in June from 2.6% in May. The global food prices have been rising for the fifth consecutive month since its multi-year low registered in January.

On a YoY basis, the price growth in Food & Non-Alcoholic Beverages index edged up to 4.2% in June, compared to 4.1% in May. However, it was still considerably lower than the year’s high of 5.0% YoY registered in March.

Inflation in the Housing, Water, Electricity, Gas & Other Fuels category (23.8% share of CPI) remained stable at 2.4% YoY. On a MoM basis, the price was unchanged in June following a 0.5% increase in May.

Transport cost (13.7% share of CPI) fell 0.1% MoM and declined at a steeper rate of 8.5% YoY (May: -5.6%). This is largely due to a higher base comparison resulted from a fuel price hike in the corresponding month of last year. In June, the government-regulated RON95 petrol price was maintained at RM1.70 a litre, adding no inflationary pressure to the declining transportation index.

Further afield, inflation remains weak in major developed economies. Singapore and Japan sank further into deflationary territory while China June inflation moderated to 1.9% YoY from 2.0% YoY in May. On the other hand, Eurozone managed to shake off deflation with a mild 0.1% YoY price growth in June. Overall, inflation in major economies remains well below their respective official target. This could warrant world central banks to maintain their loose monetary policies.

Outlook

As the base effect remains prevalent, we expect the CPI to moderate further to 1.4% in July in spite of RON95 petrol prices were raised by 5 sen. This is further mitigated by last year’s fuel price hike in July (up 10 sen) before successive price cuts were made. Meanwhile, the subsiding cost pass-through effect from the implementation of GST and lower fuel prices in the later part of last year will likely result in higher inflation reading in the remaining months of the year. Hence, we project the CPI to rise back to around 2.0% YoY in 4Q16.

Furthermore, food price inflation is expected to gain traction due to gradual rise in global food prices and the lagged impact of El Niño weather conditions on foods harvest. The Food & Non-Alcoholic Beverages sub-index is expected to remain high in July, supported by higher food demand during the Eid festive period.

The weak global growth momentum has prompted us to revise our 2016 GDP forecast to 4.0%-4.5% from 4.5%. We expect consumer sentiment to remain weak in the face of elevated uncertainties in the domestic economy, with a downside bias in consumer spending. A stronger ringgit, low energy prices and tight lending conditions could keep the inflation in check. In view of the weak domestic growth prospect and consumer sentiment, we revise down our full- year inflation forecast by 0.3 percentage points to 2.3% YoY.

We see the BNM decision to cut the OPR by 25 bps in July to have limited impact on domestic inflation in the near term, considering the transmission lag of monetary policy and weak consumer sentiment. However, the low official core inflation could provide BNM the flexibility to ease its monetary policy if needed. For now we expect BNM to keep the OPR at 3.00% for the remainder of the year. If disinflationary trend continues unabated along with weaker growth prospects it may give BNM more room to cut interest rates sooner than later.

Source: Kenanga Research - 21 Jul 2016