OVERVIEW

● May’s inflation edged higher for the second month in a row to a four-month high of 1.8% YoY (April: 1.4%). The month’s inflation matched Bloomberg’s median consensus estimate but came in slightly lower than the house estimate of 1.9% YoY. We may have underestimated the preceding year’s lower base effect that elevated this month’s inflation level. However, compared to the preceding month, inflation edged higher to 0.2% following elevated transportation as well as housing, water and electricity price levels.

● Higher transportation prices were the main contributor of May’s higher inflation index. The transportation index surged to 3.8% YoY in May (April: +0.4%) due to higher retail fuel prices during the month. Weighted average retail fuel prices for RON95 and RON97 were higher at RM2.2000/litre and RM2.4700/litre respectively in May (May 2017: RM2.0926/litre and RM2.3726/lire respectively). The index edged up 0.1% MoM even though retail fuel prices were capped during the month.

● While food prices edged down to the lowest since January 2013 at 2.2% YoY (April: 2.6%), the index was up by 0.2% MoM (April: -0.2) possibly due to the depreciation of the Ringgit and subsequently higher price of imported goods. The month’s higher inflation level was also due to higher housing, water and electricity price levels which edged up to 2.1% YoY (April: 2.0%) in line with the seasonal-driven changes during the month.

● Despite the month’s relatively elevated inflation level, we expect it to be temporary and to moderate in 3Q18 possibly to below 1.0% following the government’s decision to reduce the Goods and Services Tax to zero effective 1st June. However, we do expect some offsetting effect to the moderation in inflation level from the reintroduction of a replacement levy in September. Additionally, the government has set aside RM3.0b for the reintroduction of fuel subsidies which will keep retail fuel prices at its current level and further moderate the transportation prices in 2H18.

● Hence, we expect full year inflation to be lower at between 1.0-2.0% from 2017’s 3.7%. This is significantly lower than Bank Negara Malaysia’s 2.5-3.5% target for 2018. Year-to-date, inflation level is gradually descending at 1.7% compared to 4.1% in the same period last year. Therefore, while some emerging market Asian economies are trying to play catch up to Fed rate hikes, we see ample room for BNM to keep its interest rates on hold at 3.25% in the interest of supporting domestic demand as global trade tensions is expected to weigh on economic growth in 2018.

Source: Kenanga Research - 21 Jun 2018