OVERVIEW

• Expectedly unchanged. The Monetary Policy Committee (MPC) held the Overnight Policy Rate (OPR) at 3.00% after its meeting last Friday (12th May), in line with Bloomberg’s median consensus estimates and the house expectation.
• Optimistic on synchronous global growth trend. BNM was largely positive on a synchronous growth across both advanced market economies (AME) and emerging market economies (EME). Back home, growth will again be driven largely by domestic demand with a stronger support from the external sector.
• Inflation uptick likely to moderate in 2H17. While noting that 1Q17 inflation surge to 4.3% was largely due to the passthrough impact of higher global oil prices and temporary disruptions in food supply, BNM expects headline inflation to moderate in 2H17 with underlying inflation seeing only modest increases in between.
• In search of a stronger signal. We maintain our overall neutral view on the OPR trajectory moving forward. Despite a growing tightening bias arising from cost-push inflation, we believe that the presently stable core inflation trend warrants a more cautious stance towards rate tightening.

Status quo prevails. As expected, the MPC held the OPR at 3.00% in line with house and Bloomberg’s consensus estimates (which was unanimous among 22 respondents). The MPC last cut interest rates in its July 2016 meeting, citing the need to ensure a steady domestic growth path.

Sanguine on growth. Once again, the MPC was overall positive on growth prospects, citing continued improvements in global economic outlook. Global growth was synchronous among both AMEs and EMEs though slightly different growth catalysts. Growth in the AMEs was largely underpinned by revival of investments while EME growth is sustained by a mixture of sustained domestic activity and stronger external demand. The MPC, however, cautioned against continued threats from protectionism, geopolitical developments and commodity price volatility. Back home, the MPC sees the strengthening growth momentum of 2H16 strengthening in 1Q17 and subsequently carrying itself for the rest of the year. Growth will be driven by domestic demand with consumption supported by wage and employment growth and investments buoyed by the implementation of new and ongoing projects. This will further be supplemented by improvements in the external front arising from a more positive global growth, hence leading to a stronger external contribution to headline growth.

Higher inflation weighs. The MPC notes that inflation rose to 4.3% in 1Q17, largely from pass-through effects of higher global fuel and food prices (from transient supply-side disruptions). Further inflation is likely to be dependent on the highly uncertain global oil prices though clearly the MPC expects inflation to moderate somewhat by 2H17. Regardless, the broader price trends are expected to remain largely unchanged amid stable domestic demand conditions even as core inflation sees just modest increases.

Ringgit stable; healthy financial system. The MPC is broadly positive on the ringgit, banking system liquidity and financial institutions. The monetary policy statement suggests that financial intermediation appears to be working normally with no prominent developments in these areas. Indeed, the statement largely dropped references to financial market development measures.

OUTLOOK

Too early to raise rates. Despite some signs of strength in domestic demand and record high inflation reported in March, we believe that it is still too early to support the case for raising interest rates just yet. On the contrary, present rates remain consistent with BNM’s objectives for supporting steady growth, stable inflation and healthy financial intermediation.

Nascent growth underway. Based on the recent IPI and PMI data, we are seeing some building blocks for Malaysia’s domestic-driven recovery narrative. This is further supplemented by the bullish external trade data suggesting additional support from the external sector. Following a sharp rebound in output growth of palm oil and rubber along with stronger manufacturing, we recently revised our GDP growth projection to 5.0% growth for 1Q17 though we retain a 4.8% full year growth forecast for 2017. Regardless, we believe that it will take multi-period improvements in Malaysia’s growth trajectory to justify a tightening of the monetary policy levers. A pre-emptive tightening risks diminishing the growth catalysts, particularly in the domestic economy.

Heightened but manageable inflation. The consumer price index grew by 5.1% in March (1Q17: 4.3%), its fastest pace since November 2008, largely from transportation sector inflation given higher oil prices since last year. We reckon that inflation is likely to remain elevated above 4.0% for 2Q17 and 3Q17, largely from the lower base effect of 2016 with a full year forecast of 4.4%, However, despite higher inflation, we believe that the broader price trends remain under control with core inflation largely unchanged at 2.5% YoY in March (1Q17: 2.4%), substantially lower than 3.6% during 1Q16, suggesting that broader price trends remain intact. Furthermore, we believe that oil prices have stabilised somewhat and may indeed be coming off slightly to the mid USD50-55/barrel area – weighted average retail fuel prices certainly suggest so. This implies that inflation may have peaked in March. As such, while further tightening cannot be ruled out, we reckon that BNM will adopt a wait-and-see stance if indeed a tightening of the monetary policy is needed in the absence of an immediate need to dampen inflation.

Financial market stability. Monetary aggregates were somewhat higher in March though with an accompanying increase in private sector financing also observed during the same period. This, as the monetary policy statement implies, is consistent with the pace of economic activity. The lack of mention of financial market development measures may suggest that the MPC is overall comfortable with the ringgit stability (despite the ringgit depreciation observed in recent weeks) and capital market stability. Also notable was the absence of Fed rate hike trajectory, which suggests that BNM’s policy may be largely independent on the Fed’s planned rate hikes but instead, geared towards domestic factors.

Source: Kenanga Research - 15 May 2017