KUALA LUMPUR (May 19): As Central Banks around the world are racing to raise interest rates to tame inflation, some quarters argue that an interest rate hike at this juncture is not an effective measure to address the current situation in which prices are driven up mainly by higher costs as a result of the sharp rise of commodity prices plus supply chain disruption.

The Bank of Japan (BoJ) is probably among the outliers. It indicated that it would not raise rates that soon. Its Governor Haruhiko Kuroda commented that a tighter monetary policy would be inappropriate in dealing with cost-push inflation.

Bank Negara Malaysia (BNM) has joined its peers to raise the overnight policy rate (OPR) by 25bps last Wednesday (May 11) to 2% after keeping a record low rate of 1.75% since July 2020.

When contacted MIER chief economist Dr Shankaran Nambiar told The Edge that the rate hike would not address rising costs, as inflation is being driven more by supply constraints amid the Ukraine conflict, China’s Covid-19 containment policies and supply chain restrictions, rather than demand-pull factors.

“There is pent-up demand, but that is not likely the cause for the increase in the price of fertilisers, vegetables or oil. We are looking at inflation that is more generated by cost-push rather than burgeoning demand.

“That being the case, the rate hike will hardly be able to make a dent on cost-related pressures,” said Nambiar.

Instead, the bigger concern is price stickiness, he said, as prices will unlikely normalise even after the resolution of the Ukraine conflict and China’s Covid-19 situation has improved. Eateries, for example, are unlikely to reduce prices.

Meanwhile, some see wage increase as a result of inflation could possibly form a vicious cycle as any pay hike could fuel inflationary pressure.

Nambiar believes policy makers should look for remedies to address the causes of inflation, rather than the symptoms.

“Measures should pre-emptively address price stickiness. Labour shortages in the agriculture sector should have been addressed quickly. Anti-competitive arrangements, especially with government support, should be dismantled, and this is the best time to undertake such measures,” he said.

“A more competitive environment for the distribution of rice might better help lower the price of rice rather than a subsidy,” he added.

The government has agreed not to impose the Approved Permit (AP) requirement for import of foodstuffs with immediate effect.

Prime Minister Datuk Seri Ismail Sabri Yaakob said the decision was reached at the Cabinet meeting on Wednesday (May 18) to ensure sufficient food supply.

However, there are others that opine raising interest rates now at a gradual pace is something that needs to be done.

UOB Malaysia’s senior economist Julia Goh said that raising interest rates now when there are signs of improvement in the economy with higher inflation risks is a better option than to be left behind the curve, as that tends to lead to more abrupt and faster pace of rate hikes in the future.

She points out the situation in the US — in early May, the US Federal Reserve raised rates by 50 basis points, the highest increase in 20 years to tackle high inflation.

MARC chief economist Firdaos Rosli concurs that an OPR hike is the best policy alternative to keep inflation at bay, on top of the current supply-side measures already deployed by the government such as subsidising petrol pump price and other price control measures.

While he agreed that inflation is being driven more by cost-push factors such as the strengthening of the US dollar amid rapid economic recovery and aggressive US rate hike prospects, he said that demand-pull factors are also present.

“It is a bit of both, but I am more inclined to say it is more cost-push amid supply bottlenecks and high commodity prices. On the one hand, we see good upticks in private consumption, and some domestic investments of late, so demand-pull is notable,” he said.

Unemployment rate has been holding at 4.1% as more workers return to the workforce with the reopening of the economy. Private sector wages have also increased by 4.7% in the first quarter.

UOB Malaysia’s Goh added that supply-driven price pressures can easily turn into demand-driven pressures that pushes up inflation risks.

“As such, BNM has highlighted that they are staying vigilant on potential second round effects that can turn fast as the labour market improves,” she explains.

For now, there seems to be no concern of stagflation happening in Malaysia. With the economic recovery looking robust judging from the first quarter GDP of 5% and unemployment rates improving, economists opine that it is not a concern currently.

“We think the economy can withstand the rate hikes if they are gradual and measured. At this juncture, despite the lingering external risks, we think there are sufficient domestic growth drivers with the reopening of the economy and transition to endemicity to sustain the growth momentum in the coming quarters,” said Goh.

Inflation contained so far, why?

That being said, Malaysia’s inflation has been largely contained as a result of the price control measures and fuel subsidy given by the government. For the first three months of 2022, headline inflation ranged between 2.2% and 2.3% year-on-year.

MIER’s Nambiar believes that the government should hold off on using subsidies as a policy instrument for as long as possible, although temporary subsidies could be “tolerable”.

BNM governor Tan Sri Nor Shamsiah Mohd Yunus echoed a similar sentiment during the first quarter GDP briefing, stressing that while price controls and fuel subsidies have moderated price pressures here, these were short-term measures.

Longer-term measures, BNM said, include the improvement of productivity levels through efforts like digitalisation and upskilling.

https://www.theedgemarkets.com/article/will-rate-hikes-tame-costpush-inflation-effectively