OVERVIEW

● Headline inflation fell 0.4% YoY in February (Jan: -0.7%), a tad lower than the consensus estimate of -0.3% but lower than house estimate of +0.1%. This is its second consecutive month of decline since the 2009 Global Financial Crisis. On a MoM basis, the index rebounded by 0.2% after it fell by 0.5% in the preceding month. Meanwhile, core inflation edged up by 0.3% YoY (Jan: 0.2%) but remained subdued raising concern that the economy is slowing. Inflation has remained subdued since June 2018 following the tax holiday period and government decision to maintain fuel subsidy amid higher crude Brent oil price in 2H18 before moving to retail oil pricing mechanism in early 2019.

● Lower transport prices outweighed rising food, and housing, utility and fuel prices. The food index growth was unchanged at 1.0% YoY for the second straight month, reflecting heightened demand ahead of the Chinese New Year. Meanwhile, the housing, water, electricity, gas & other fuels index growth was also unchanged at 2.0% YoY but it rebounded by 0.5% MoM (Jan: 0.0%). Despite the increases mentioned above, the overall consumer prices remained in negative territory due to a significant drop in the transport index (-6.8%; Jan: -7.8%), as average retail oil prices in February remained low at RM1.99/litre for RON95 compared to the same period a year ago at RM2.26/litre. Tracking a similar path, RON97 and Diesel were much lower at RM 2.28/litre and RM2.18/litre respectively (Feb-18: RM2.53/litre and RM2.24/litre respectively). The lower retail oil price was mainly due to the reinstatement of the weekly managed float system on 5th January, as the government wants consumers to immediately benefit from any downward movement of the global oil prices, whilst protecting them from higher prices by introducing a lower price ceiling of RM2.08/litre from the initial RM2.20/litre for RON95 and RM2.18/litre for diesel. Of note, the average Brent crude oil price has recently gained strength on the back of the ongoing OPEC’s supply cut (Feb: USD64.0/barrel, Jan: USD59.4/barrel). Hence, we foresee that the inflationary trend would gradually normalise in the coming months.

● Moderating inflation in the advanced and developing economies amid lower energy prices (Feb. average Brent crude oil price: -2.1% YoY). US inflation slows in February to 1.5% YoY (Jan: 1.6%), the lowest since 2016 on cheaper gasoline prices, which is partly the reason why the Fed has been dovish and announced that it may not raise interest rate this year from its initial guidance of two rate hikes. Meanwhile, inflationary pressure in the Eurozone seemed to have increased slightly, up by 1.5% YoY (Jan: 1.4%). However, on the back of an underlying weak inflationary trend the European Central Bank (ECB) has slashed its inflation forecast to 1.2% this year from the initial 1.6% as uncertainties ranging from geopolitical risks to trade rows hampered the eurozone economy. In Asia, headline inflation in China and Indonesia eased further to 1.5% and 2.6% YoY respectively (Jan: 1.7% and 2.8% respectively). This has partly influenced Bank of Indonesia to leave its policy reverse repo rate on hold at its latest meeting last week.

● Notwithstanding the two-straight month of deflation we reckon the headline inflation growth would turnaround and normalise as the high base effect in the transport component subsides and the targeted fuel mechanism is introduced latest in July. However, we expect any upside would be limited largely due to heightened risk on external factors namely cooling global growth arising mainly from growth slowdown in China and the EU Zone, the US-China trade tension, and Brexit. Against this backdrop, we believe that inflation would likely hit the lower end of our forecast range of 1.0-1.5% in 2019 (2018: 1.0%). This would provide Bank Negara Malaysia (BNM) a bigger leeway to cut its overnight policy rate. However, a rate cut may not be a conclusive solution yet, unless signs of slowing growth sharply deteriorate. We forecast the GDP growth to grow by 4.4% in the 1H19 before slightly improving to 4.5% in the 2H19, bringing our whole year GDP forecast to 4.5%, still decent by regional standard though slower than 4.7% last year. In the near term, we do not see the need for BNM to cut its policy rate lest it triggers a bigger capital outflow and sharply devalue the Ringgit.

Source: Kenanga Research - 25 Mar 2019