OVERVIEW

Consumer price inflation trended down to 1.1% YoY in July, the lowest in 16 months. The headline inflation was just a tad below the consensus and house estimate of 1.2% YoY. The low inflation was mostly due to the declining fuel price on an annual basis. In addition, a tapering of the food & beverages index exerted additional downward pressure on price growth. By category, Transport (13.7% share of CPI) rose 1.5% MoM but plunged 9.9% YoY on a high base effect. Food & Non-Alcoholic Beverages rose a smaller 3.8% YoY compared to 4.2% in previous month. We believe that inflation has hit its trough in July and will likely trend higher in subsequent months, partly due to a smaller disinflationary pressure in the transportation sector. Despite the positive performance of recently published economic indicators, we continue to see uncertainties in the domestic growth prospects and consumer spending behaviour. As such, we revised our full-year inflation forecast to 2.1% YoY from 2.3%. We expect Bank Negara Malaysia to keep the OPR at 3.00% for the remainder of the year. 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) moderated to a 16-month low of 1.1% YoY in July, compared with 1.6% YoY recorded in June. The CPI has been on a moderating trend for the fifth consecutive month. The headline rate was a tad lower than the consensus and house estimate of 1.2% YoY. The CPI grew 0.3% MoM compared with 0.2% in June.

The disinflationary pressure in the transportation sector has largely resulted in July’s weak inflation. The transportation cost is falling due to the lower fuel cost on a yearly basis. Furthermore, a moderation in the food & beverages index exerted additional downward pressure on the July headline inflation.

The year-to-date average YoY growth for CPI was 2.4% compared to 1.7% in the corresponding period a year ago. Meanwhile, core inflation edged down 0.1 percentage point to 2.0% YoY in July.

The Food & Non-Alcoholic Beverages index with a 30.2% share of the CPI experienced a slower growth of 0.3% MoM in July, compared with 0.5% in June. This is consistent with the United Nations Food and Agriculture Organisation’s (FAO) Food Price index. The FAO Food Price Index edged down 0.8% MoM in July, ending a five consecutive months of rising trend. We believe it is taking a breather before resuming its upward trend.

On a YoY basis, the price growth in Food & Non-Alcoholic Beverages index moderated to 3.8% in July, compared to 4.2% in June. It was also lower than the average 4.4% YoY growth registered in 1H16.

Inflation in the Housing, Water, Electricity, Gas & Other Fuels category (23.8% share of CPI) has remained steady at 2.4% YoY. On a MoM basis, the price has remained unchanged in July for two consecutive months.

Transport cost (13.7% share of CPI) declined at a sharper rate of 9.9% YoY (June: -8.5%). This is due to a higher base comparison following a RON95 petrol price hike of 10 sen in the corresponding month of last year. In July, the petrol price was raised by 5 sen. This has actually contributed to the 1.5% MoM growth in the transport index in July.

The world’s major economies are mostly mired in weak inflation. Singapore and Japan is still undergoing deflation while China’s July inflation moderated to 1.8% YoY from 1.9% YoY in June. Although inflation has picked up, Eurozone’s inflation remains low at 0.2% YoY in July. Overall, inflation in major economies remains well below their respective official target. This may signal a continuity of loose monetary policies from their central banks.

Outlook

We expect inflation to hit its trough in July and to trend higher in August and subsequent months, partly due to a smaller disinflationary pressure in the transportation sector. The popular RON95 petrol price was unchanged in August while it decreased by 10 sen in the corresponding month of last year. Meanwhile, as the high base effect remains prevalent, we expect any upside to the inflation trend would likely be tempered for the remaining months of the year. We project the CPI to average 1.3% YoY in 3Q16 and 1.6% in 4Q16.

Furthermore, food price inflation is expected to remain high due to the upward trend in global food prices and the prolonged negative impact of El Niño weather conditions on food supply.

Despite the better performance of recently published economic indicators, the domestic growth prospects with regards to consumer spending behaviour remain uncertain. In addition, a relatively weak ringgit, low energy prices and tight lending conditions would likely put a cap on the upward pressure of domestic inflation this year. As such, we revised our full-year inflation forecast to 2.1% from 2.3% YoY.

We see the BNM decision to cut the OPR by 25 bps in July to have limited impact on domestic inflation for the year, considering the transmission lag of monetary policy impact 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.

Source: Kenanga Research - 25 Aug 2016