OVERVIEW

• OPR expectedly held at 3.00%. The Monetary Policy Committee (MPC) held the Overnight Policy Rate (OPR) at 3.00%, in line with ours and market expectations.
• Firming domestic and external demand. Continuing from its January’s narrative, the MPC was notably more optimistic on economic prospects for Malaysia, anticipating resilient domestic demand and improving external conditions.
• Cost push pressures weighs. The MPC notes higher inflation in January, largely from higher global oil prices, though the MPC do not expect this to affect the broader price trend. However, inflation is expected to persist throughout 1H17.
• OPR 2017 outlook: unchanged. We maintain our view that the OPR will remain at 3.00%, at least in 1H17 in the absence of any deterioration to growth and the steady rise of inflation. At the current level, we believe the OPR is both accommodative of growth while sufficient in keeping inflation in check.

Status quo as expected. The MPC maintained the OPR at 3.00% in line with our estimates and Bloomberg’s survey of 17 economists (with just one panellist expecting a 25bp cut).

Upward growth bias. The MPC retained its upbeat tone on growth noting improving economic activity in both the advanced and emerging market economies, on stronger domestic and external demand. The MPC further highlighted the expansion of 4.2% GDP growth in 2016 underpinned by private sector activity with additional support from recent rebound in exports despite challenging global and domestic conditions throughout the year. It expected the growth momentum to be sustained in 2017 on the back of improvement in exports and sustainable domestic demand growth.

…but Inflation risks heightened. Inflation was a more prominent feature of this monetary policy statement as the MPC noted higher headline inflation for 2017 (January: 3.2%), largely from the “pass-through impact of the increase in global oil prices on domestic retail fuel prices.” The MPC expects higher inflation to be the narrative throughout 1H17 before gradually moderating, with some modest impact on core inflation. However, the MPC expects that the cost-push factors would not have “a significant impact on the broader price trend given the stable domestic conditions.”

Stabilising ringgit and ample liquidity. Inflation appears to have replaced ringgit volatility concerns as the MPC’s key considerations. The statement cites the successful implementation of its financial market development measures together with the sufficient banking system liquidity as main factors bringing about a positive impact on the domestic financial markets. Since mid–February the USDMYR has been stable and trading at around 4.45. The ringgit kicked off the year at 4.4995 to the dollar (at mid-day session on Jan 4), its weakest since the 1997/98 Asian financial Crisis.

OUTLOOK

OPR outlook unchanged. Firming demand and inflation variables reinforces our long-held view that the OPR is unlikely to be changed, at least for 1H17. Indeed, in the absence of major negative surprises to growth or sharp spikes in inflation, we expect the OPR to remain at 3.00% for 2017.

Upside growth bias. With an unexpectedly high GDP growth of 4.5% in 4Q16 (supported by private sector and strengthening external demand) along with signs of a resurgent manufacturing sector, we are optimistic on Malaysia riding the prevailing recovery momentum despite possible external uncertainties. Backed by sustained domestic demand growth driven by private consumption along with improvement in exports GDP growth is projected to expand by 4.5% in 2017.

Just right for now. We are starting to see signs of cost-push inflation, at least for 1Q17, largely driven by higher fuel prices, imported price inflation due to the weak ringgit and, to some extent, low base rate effects. We expect January’s elevated consumer inflation to spill into February on similar fuel price increases, culminating in a 1Q17 inflation of 4.1% (2016: 2.1%). This, in turn, sharply reduces the odds of a rate cut moving forward. We believe that a 3.00% OPR is both accommodative of growth while keeping inflation in check. Furthermore, with the US Federal Open Market Committee members projecting an increasingly hawkish stance (with 84% odds of a 25bp hike in its upcoming meeting on 14-15th March as shown on graph 2), global policy uncertainties and ringgit volatility, we believe that the conditions are less conducive for a rate cut.

Further assessment awaits. Moving forward, our view of the OPR will be shaped by ongoing assessment on Malaysia’s recovery trajectory, further changes in inflation, the ringgit movements and other external factors including details of US President Donald Trump’s economic policy, post-Brexit framework and the progress of OPEC’s production cuts.

Source: Kenanga Research - 3 Mar 2017