? On a continued downtrend. July’s consumer price index (CPI) remained on a downward trajectory for the fourth consecutive month. Its YoY growth rate moderated to 3.2% (June: 3.6%), below the consensus estimates of 3.4% and the house estimate of 3.2%

? Transportation eases on cheaper oil. The transportation index likewise eased for the fourth consecutive month, falling below the double-digit mark achieved during February-May with a slower inflation of 7.7% (June: 10.5%). On a MoM basis, the transportation index likewise declined though at a slower 1.1% (Jun: -2.4%).

? Food price inflation falls again. Food inflation was lower for the second consecutive month at 4.2% (Jun: 4.3%) after peaking at 4.4% in May. In MoM terms, the food index also rose by a slower 0.2% (Jun: 0.4%)

? Core inflation rises again. Broader price trends, as reflected in the core CPI, edged up slightly to 2.6% (Jun: 2.5%), equalling the levels seen during Apr-May. However, given the small quantum of increase, it remains to be seen if this marks a start towards higher demand-pull factors.

? OPR likely to remain at 3.00%. While we are seeing increasing signs of demand-pull factors in the macro-data, the case for raising interest rates in the near future remains remote at best. Core inflation remains low and relatively manageable even at 2.6%. Despite higher GDP growth, it may be premature to tighten monetary policy given signs of moderation in domestic demand. As such, we reiterate our view that the OPR will be maintained at 3.00% for 2017.

Receding inflation. The consumer price index (CPI) growth moderated for the fourth consecutive month in July at a slower 3.2% YoY (Jun: 3.6%). July’s number was below the median Bloomberg consensus forecast of 3.4% (ranging from 3.2%- 3.6%) and was likewise lower against the house estimate of 3.3%. On a MoM basis, CPI fell by a slightly slower 0.1% (Jun: -0.2%), its fifth consecutive month of decline. The CPI inflation fell by a similar degree on a seasonally-adjusted basis.

Core inflation expands. However, underlying inflation, as measured by core inflation, grew by a faster 2.6% (Jun: 2.5%), equalling levels seen in May. This is roughly in line with signs of higher demand based factors seeping into price levels.

Transportation inflation continues hitting the brakes. As anticipated previously, the transportation index (comprising 13.7% of headline CPI) eased significantly to 7.7%, its lowest level in 2017. After zooming to a peak of 23.0% in March, the subindex subsequently eased for four consecutive months on moderating retail fuel prices. On a MoM basis, the transportation index fell by a 1.1% (Jun: -2.4%) reflecting a slower decline in retail fuel prices.

Retail fuel prices falling by a slower quantum. The weighted average retail prices for RON95 and RON97 came off slightly at RM1.958/litre and RM2.212/litre respectively during July (June: RM2.002/litre and RM2.267/litre), though theweighted average price of diesel rose marginally to RM1.934/litre (June: RM1.924/litre). The decline in both RON95 and RON97 prices occurred despite the general increase in crude oil prices in July, suggesting a lag effect in the weekly fuel adjustment mechanism – prices of RON95 and RON97 did rise weekly throughout July albeit moderately.

Food prices eases further. The food and non-alcoholic beverages index (comprising 30.2% of headline CPI) rose by a slower 4.2% YoY (Jun: 4.3%), easing for the second consecutive month since May. Food prices were likewise slower on a MoM basis, rising by a slower quantum of 0.2% MoM (Jun: 0.4% MoM). Among the food categories, inflation in the oils and fats categories was stable at 39.5% (Jun: 39.4%) while vegetable prices were slightly higher at 3.3% (Jun: 1.8%). Other major food components, however, including fish and seafood (Jul: 7.2%; Jun: 6.7%), fruits (Jul: 3.7%; Jun: 3.6%), and meat (Jul: 4.2%; Jun: 1.3%) saw inflation retreat somewhat during the month.

Global food prices edge higher. Lower domestic food inflation contrasts with higher global food prices. The FAO food price index grew at a faster 2.2% MoM (Jun: 1.4% MoM), hitting its highest level since January 2015. Higher global food prices were largely driven by cereals, sugar and dairy sub-indices arising from a combination of supply constraints (e.g.: tighter export availabilities for butter), demand side considerations (e.g.: strong buying activity among Asian importers for cheese and whole milk powder) and currency movements (e.g.: appreciation in the Brazilian Real resulting in a de facto increase in sugar price subindex).

Housing, water, electricity, gas and fuel prices remain stable. The housing, water, electricity, gas and fuel index (comprising 23.8% of headline CPI) remained unchanged at 2.2% YoY. As with the previous month, the index was flat MoM.

Global inflation mixed. Inflation was relatively mixed globally. While consumer edged up a touch to 1.7% in US (Jun: 1.6%), inflation remained weaker than anticipated and remains a key policy challenge for the Fed’s tightening agenda. Among the Eurozone, inflation was flat at 1.3% (Jun: 1.3%) despite more optimistic sentiments. Regionally, inflation was generally stable though Indonesia’s inflation dropped to 3.9% (Jun: 4.4%), likely supporting Bank Indonesia’s recent decision to cut interest rates by 25bp to 4.5% on Tuesday (22Aug) – in addition to their narrative of supporting growth.

OUTLOOK

Transportation index likely up in August. The prices of RON95, RON97 and diesel continued from July’s upward trajectory resulting in a higher weighted average prices overall for August. As of 24 August, the weighted average prices of RON95, RON97 and diesel rose to RM2.116/litre, RM2.385/litre and RM2.037/litre respectively (Jul: RM1.958/litre, RM2.212/litre and RM1.934/litre respectively), suggesting that the transportation index may have bottomed out as global oil prices sees recovery. Assuming other drivers of inflation, particularly food, remains stable, the data presently points to a slightly higher August inflation, possibly at the upper end of 3.5-3.8% range. This implies the possibility of supply-based factors arising as a narrative for August’s inflation numbers. However, moving forward, we expect oil prices to range at the USD47-52/barrel levels (2016: USD46/barrel) moving forward.

Consistent with strengthening fundamentals. While the headline CPI eased somewhat in July as anticipated in our previous report, of interest in July’s CPI statistics is the uptick in core inflation. July’s core inflation is among the highest since April 2016 (equalling that of May 2017). Given that core inflation is reflective of broader price trend, this lends credence to the idea of improving demand-based factors into the inflation equation, as reflected by Malaysia’s strong 2Q17 GDP growth of 5.8% (1Q17: 5.6%). This is further supported by relatively strong retail numbers overall.

...but premature to tighten monetary policy. Despite strengthening demand-based factors, we believe that core inflation remains relatively low, at least relative to 1Q16 where core inflation was in excess of 3.5%. Given the relatively mild uptick in core inflation, broader price trends remain manageable overall with little signs of the economy overheating. Furthermore, despite stronger 2Q17 GDP numbers, it is worth noting that the national account statistics also suggests that domestic demand has eased somewhat. Indeed, our base case scenario for full year inflation remains at 4.1% (considering higher inflation in 1Q17 and a mild uptick in recent fuel prices). These combined factors point to a more cautious approach with the monetary policy levers. As such, we reiterate our position of the OPR likely to remain unchanged for the rest of 2017 at 3.00%.

Source: Kenanga Research - 24 Aug 2017