OVERVIEW

? December inflation edges up, meets forecasts. December’s consumer price index (CPI) reverses previous two months of moderation, rising slightly to 3.5% year-on-year (YoY) from November’s 3.4%. All in, full year inflation gained 3.7% (2016: 2.1%). Meanwhile, core inflation remained unchanged from the previous month at 2.2% YoY.

? Higher food and transportation index lift headline inflation. The rise in December’s CPI was mainly due to higher food and non-alcoholic beverage (4.1%) and transport (11.5%). Year-end festivity raises prices of local produce, while the year-end monsoon season lead to supply shortages of certain food items. High global oil prices continue to elevate transportation cost.

? Commodities boom to lead global inflationary effect. Along with the increase in oil prices, we foresee a rise in food prices leading to a mild global inflationary effect. Nonetheless, we expect the strength of the local currency to curb imported inflation, thereby exerting downward pressure to 2018’s headline inflation, which is projected to moderate to 2.8%.

? To hike or not to hike. High inflation that comes with solid economic growth momentum in 2017 and increasing hawkish stance from major central banks are key factors raising our expectations for a rate hike decision today (25 Jan, 3:00 pm). However, it may not be a major surprise if BNM decides to defer or remain status quo as uncertainty looms ahead of the upcoming General Election. Plus, capital inflows, largely hot money, have been strong lately.

December’s inflation edges up, meets forecasts. Inflation edged up slightly in December to 3.5% YoY, reversing last month’s moderation of 3.4% YoY (Oct: 3.7%), while meeting consensus and the house’s forecasts for the month. On a monthly basis, inflation moderated to 0.1% in December from 0.7% the previous month, suggesting the dissipation of transitory effect of higher fuel prices. Core inflation, excluding food and non-alcoholic beverages, was unchanged from previous month’s 2.2% YoY growth.

2017 CPI up 3.7%. December’s inflation sums the 2017 full year inflation to 3.7% (2016: 2.1%), the highest since 2008. Despite a significant increase in the headline inflation, core inflation for the year stayed at 2.4% (2016: 2.5%), reflecting the volatile and transitory effects of oil prices on consumer prices.

Seasonal factors push food prices higher. A norm of consumption during the year-end, food prices picked up during the last month of the year, registering a YoY growth of 4.1% (Nov: 4.0%) as retailers adjust prices in anticipation of a surge in consumption for the upcoming Lunar New Year in February. The higher food prices also reflect the rise in prices of local food produce, in particular fish and seafood as well as vegetables which were in shortage due to the monsoon season. Similarly, on a MoM basis, the food and non-alcoholic beverages index rose by 0.7% (Nov: 0.4%). Globally, food prices moderated further in December, as reflected by the Food and Agriculture Organisation (FAO) Index which fell 3.3% MoM in

December, averaging at 169.8 points in the month as strong production and weak export demand results in lower quotations for palm prices. Sugar prices, similarly, fell on the back of subdued demand and expectations of a larger surplus in 2018 from stronger production in Brazil, India and Thailand. For the whole of 2017, global food prices rose 8.2% YoY from 2016, representing the highest annual average since 2014.

Higher global oil prices push up transportation cost. December’s transportation index expanded by 11.5% YoY from 10.8% YoY previously but declined on a MoM basis by 0.7%, from 3.3% in November. Though a lower base effect could explain the YoY expansion it also demonstrates that the rise in petrol prices had already begun to normalise. The December weighted average retail prices for RON95 and RON97 fell to RM2.2745/litre and RM2.5487/litre respectively (Nov: RM2.3037/litre and RM2.5913/litre respectively), while the price of diesel rose to RM2.2265/litre from RM2.2110/litre in November. Brent crude prices rose by 17.7% during the month (Nov: 26.0%), while Tapis oil price rose by 19.4%, from 29.2% the previous month.

Electricity index to remain soft. The housing, water, electricity, gas and fuel index retained its 2.2% YoY growth following Tenaga Nasional Berhad’s (TNB) decision to defer raising electricity tariffs in Peninsular Malaysia. Given that TNB has fixed the electricity tariff from this year till 2020 despite higher natural gas tariffs (Jan-Jun 2018), we expect the index to remain soft over the next three years, with the possibility of slight increases due to seasonal factors.

Global inflation remains low. With growth expected to reach its peak in 2018, inflation remains on the radar of major economies in their monetary policy tightening considerations. However, prices remain subdued across all major economies towards the end of last year as strengthening currencies suppress price increases from ascending commodity prices. Eurozone’s inflation moderated to 1.4% in December (Nov: 1.5%), while US’s inflation moderated to 2.1% in December, from 2.2% the preceding month. Meanwhile in Asia, Japan and Singapore’s inflation remains subdued despite strong growth trend registered across these economies. Nonetheless, moving into 2018, the prospects of rising crude oil prices, tightening labour market conditions and the Fed tax reform is expected to fuel growth and push up prices, building the case for monetary tightening across most advanced economies. Along with more hawkish stance by major central bankers, growth will likely be the major determinant of global monetary policy decisions.

OUTLOOK

Commodities rebound to drive inflationary effect. Last year’s supply cuts by the Organization of Petroleum and Oil Exporting Countries (OPEC) as well as unanticipated supply disruptions have triggered a rebound in oil prices with Brent crude oil topping USD70 per barrel towards the end of 2017. While the supply and demand imbalance still prevails in the global oil market, oil demand for 1Q18 is expected to remain strong, supported by strong global demand, supply disruptions and the collapse of the Venenzuelean oil market. Additionally, with agriculture prices hitting bottom low last year, an agriculture boom is seen ahead as demand picks up in developing economies, particularly in China, India, Russia and Asean. Along with the increase in oil prices, we foresee a rise in food prices to be causing mild inflationary effect globally.

However, the strength of Ringgit will moderate inflation. Given that the MYR is among the strongest performing Asian currency year to date, it is is expected to reduce the effect of imported inflation for the year. So far, MYR has gained almost 9.0% against USD to 3.90 since the last Monetary Policy Committee (MPC) meeting on 9th November last year mainly backed by the strong economy, a broadly weaker USD, higher oil prices, and anticipated rate hike by BNM. While the MYR is expected to take a breather moving into 2018 on the back of the impact of US tax reforms as well as an expected three Fed rate hikes, there is room for it to sustain a gradual appreciation at least in 1Q18 on healthy macro conditions, continued USD weakness, and stronger crude oil prices. As the the strength of the ringgit is expected to ease imported inflationary pressure in 1Q18, particularly on food prices, reducing the overall headline inflation. Hence, we project the headline inflation to moderate to an average of 2.8% this year.

To hike or not to hike. High inflation that comes with solid economic growth momentum in 2017 and increasing hawkish stance from major central banks as well as the signal Bank Negara Malaysia (BNM) gave last November are key factors raising our expectations that BNM may proceed with the much anticipated first rate hike for the year by 25 basis points to 3.25% on the Overnight Policy Rate during the Monetary Policy Committee’s (MPC) meeting later today (3:00 PM). However, it may not be a major surprise if BNM decides to defer or remain status quo as uncertainty looms ahead of the upcoming General Election to be held on or before 24th August this year. Plus, capital inflows, largely hot money, has been strong off late judging by the torrent of funds flowing into the equity and bonds market. As at 24th of January, net inflows of foreign funds into the stock market has continued for the past 9th straight days, totalling RM1.2b. Year-to-date, the cummulative net inflows of funds is considerably large at RM2.93b.

Source: Kenanga Research - 25 Jan 2018