Malaysia

PP 7767/09/2010(025354) MARKET DATELINE

Economic Highlights
9 July 2010

Bank Negara Raised Its Key Policy Rate By 25 Basis Points To 2.75%

Bank Negara Malaysia’s (BNM) Monetary Policy Committee (MPC) raised the Overnight Policy Rate (OPR) by another 25 basis points to 2.75% on 8 July. This was the third increase in a row for this year, in a move to prevent financial imbalances from building up and given that the economy has turned around since the 4Q of last year. Indeed, the Central Bank indicated that economic activities remained robust in the 2Q, as reflected in recent trends in industrial production, financing activity, labour market conditions and exports. Following the hike, the MPC considers “the new level of the OPR to be appropriate and consistent with the current assessment of the growth and inflation prospects”. The remark suggests that the Central Bank is likely to have done with its rate hike this year. Furthermore, the Central Bank is of the view that there is increased risk that the global growth momentum could moderate even though the recovery will continue. This is on account of rising volatility in the international financial markets, following concerns over the ongoing sovereign debt crisis in several advanced economies.

The Central Bank is holding the view that inflation will rise at a gradual pace in the coming months and moderately in 2010. We expect inflation to trend up to an average of 2.0% in 2010, from +0.6% in 2009, in line with a pick-up in domestic demand. Higher crude oil and commodity prices will also contribute to higher inflationary pressure. In addition, the Government plans to gradually remove some of the subsidies in order to reduce its financial burden. Already, the Government has allowed sugar price to be increased by 20 sen and it has removed the subsidy for white bread at the beginning of the year. Also, it has organised the Subsidy Rationalisation Lab on 27 May to get feedbacks from the public on its proposals to cut subsidies. However, we believe the removal of subsidies will likely be gradual and separately in order to reduce the burden on the people. Nevertheless, given that output is recovering from low levels, the resultant pressure on inflation from the narrowing output gap and a gradual removal of subsidies is expected to be limited.

Although inflation is expected to rise but it will not create a major

Table 1: 2010 MPC Meetings Schedule threat to the economy at this stage, in our view. However, given No Date that economic growth is gaining momentum and maintaining interest 1st 26 January 2010 (Tuesday) rates at too low a level over an extended period could encourage 2nd 4 March 2010 (Thursday) excessive risk taking behaviour and unhealthy build up of financial 3rd 13 May 2010 (Thursday) imbalances, there is a need to bring back interest rates to a more 4th 8 July 2010 (Thursday) normal level. Following which, BNM has begun normalising its 5th 2 September 2010 (Thursday) monetary conditions in March. However, we believe the Central 6th 12 November 2010 (Friday) Bank is likely to have done with its interest rate hike after raising its overnight policy rate (OPR) for the third time on 8 July. We expect the Central Bank to hold its key policy rate at 2.75% for the rest of this year, given that there is no urgency to raise interest rates rapidly and the country’s economy will likely slow down in the 2H of the year, as the global economy weakens. However, we expect the Central Bank to raise its key policy rate again in early part of 2011 and by a total of 50-75 basis points during the year, pushing the OPR to a more neutral level of 3.253.50% by end-2011.

Peck Boon Soon
Please read important disclosures at the end of this report.

(603) 9280 2163 bspeck@rhb.com.my

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