PP 7767/09/2010(025354)

Malaysia
Economic Highlights
•MARKET DATELINE

22 September 2010

Inflation Accelerated In August, But Remains

Manageable

◆ The headline inflation rate accelerated to 2.1% yoy in August, from +1.9% in July and a low of +1.2% in
February. This was the sixth consecutive month of picking up and the fastest rate of increase in 15 months, pushed
up partly by the Government’s move to increase fuel and sugar prices in mid July and partly by the lower base effect
given that inflation contracted in the same month last year.
◆ Going forward, inflation is expected to increase at a faster pace due to the Government’s move to raise fuel
and sugar prices with effect from 16 July in order to gradually reduce its subsidies. The Government has indicated
that it would reduce its subsidies once every six months. A moderation in demand as the economy softens, however,
will provide some mitigation. On balance, we expect inflation to trend up to an average of 2.8% in 2011,
from an estimate of +2.0% in 2010.
◆ Although the change in administrative pricing will lead to higher inflationary pressure, we believe Bank Negara
Malaysia (BNM) will unlikely act on it. Indeed, we believe the Central Bank is likely to have done with its interest
rate hikes this year, after raising it by a total of 75 basis points in three meetings and the overnight policy rate (OPR)
will likely stay at 2.75% until end-2010. Further out, we believe the Central Bank will likely resume with its policy
normalisation and the OPR will likely be raised by 50-75 basis points in 1H 2011 to bring it to a more neutral
level of 3.25-3.50% by mid-2011.

The headline inflation rate accelerated to 2.1% yoy in August, from +1.9% in July and a low of +1.2% in
February (see Table 1). This was the sixth consecutive month of picking up and the fastest rate of increase in 15 months,
pushed up partly by the Government’s move to increase fuel and sugar prices in mid July and partly by the lower base
effect given that inflation contracted in the same month last year. As a result, food & non-alcohol beverage prices

Table 1
Weights In The CPI
New 2008 2009 2010 2010 2009 2010
(2005=100) July Aug July Aug (Jan-Aug)
Group: Weights (%) %,yoy %,mom %,yoy %,Cum yoy

Food & non alcoholic beverages 31.4 8.8 4.1 +0.4 +0.3 2.9 3.1 5.8 2.2
Alcoholic beverages & tobacco 1.9 7.3 6.1 +0.1 0.0 3.1 3.1 8.2 3.0
Clothing & Footwear 3.1 -0.6 -0.9 +0.5 -0.6 -1.3 -1.6 -0.8 -1.7
Housing, water, electricity & gas 21.4 1.6 1.4 +0.1 +0.5 0.9 1.3 1.5 1.0
Furnishings, Household equipment 4.3 3.0 3.0 +0.4 -0.2 0.9 0.6 3.8 0.7
Health 1.4 2.2 2.2 +0.1 +0.2 1.6 1.7 2.4 1.6
Transport 15.9 8.9 -9.4 +0.8 +0.8 2.0 2.7 -9.3 1.3
Communication 5.1 -0.6 -0.5 +0.2 0.0 -0.1 -0.1 -0.5 -0.3
Recreation services & culture 4.6 1.7 1.6 +0.1 -0.3 2.6 0.3 1.1 2.3
Education 1.9 2.4 2.3 +0.1 0.0 1.7 1.5 2.5 1.7
Restaurant & hotels 3.0 6.6 2.9 0.0 +0.2 1.8 1.9 3.5 1.7
Miscellaneous goods & services 6.0 3.4 3.7 +0.1 -0.3 2.9 2.5 3.4 2.8

TOTAL 100.0 5.4 0.6 +0.3 +0.4 1.9 2.1 1.2 1.5
Core CPI 68.6 3.7 -1.1 +0.2 +0.4 1.4 1.5 -1.0 1.2

Peck Boon Soon

(603) 9280 2163
Please read important disclosures at the end of this report.
bspeck@rhb.com.my

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 22 September 2010

grew at a faster rate of 3.1% yoy in August, the faster rate of increase in 13 months and from +2.9% in July.
In the same vein, the core inflation rate inched up to 1.5% yoy in August, from +1.4% in July and after remaining
stable at 1.2% in the last three consecutive months. This was due mainly to a pick-up in the costs of transport, which
accelerated to 2.7% yoy in August, from +2.0% in July, as the full impact of the increase in fuel prices was felt. A pick-
up in the costs of housing, water, electricity, gas & other fuels; healthcare; and charges at restaurants & hotels worsened
the situation. These were, however, mitigated by a sharper drop in the prices of clothing & footwear and a slowdown
in the prices of furnishing & household products as well as the costs of recreation services and education. Prices of
alcoholic beverage & tobacco and the costs of communications, on the other hand, remained stable during the month.

A reclassification of items according to their durability and services rendered showed that the pick-up in inflation rate
was due to a faster increase in the prices of non-durable goods. This was, however, mitigated by a slowdown in the
prices of durable goods and the costs of services as well as a sharper drop in prices of semi-durable goods.

Mom, inflation rate grew at a slightly faster pace of 0.4% in August, compared with +0.3% in July. This was
attributed to a pick-up in the core inflation rate, which was mitigated by a slowdown in food & non-alcohol beverage prices
during the month. The core inflation rate accelerated to 0.4% mom in August, from +0.2% in July, mainly on account
of a faster increase in the costs of housing, water, electricity, gas & other fuels; healthcare; and charges at restaurants
& hotels. These were, however, mitigated by declines in the prices of clothing & footwear and furnishing & household
products as well as the costs of recreation services. Prices of alcoholic beverage & tobacco and the costs of
communications as well as education, on the other hand, stagnated, while the costs of transport remained stable during
the month. Meanwhile, food & non-alcohol beverage prices eased to 0.3% mom in August, from +0.4% in June.

In the first eight months of 2010, inflation rate rose by 1.5% yoy, faster than +1.2% in the corresponding period of 2009.
This was due to mainly to a pick-up in the core inflation rate, which grew by 1.2% yoy in January-August, a rebound
from -1.0% in the corresponding period of 2009. The pick-up was reflected in a rebound in the costs of transport, which
rose by 1.3% yoy in the first eight months of 2010, compared with -9.3% in the corresponding period of 2009. A pick-
up in the costs of recreation services also contributed to a faster rise in the core inflation rate. These were, however,
mitigated by a slowdown in food & non-alcohol beverage prices, which eased to 2.2% yoy in January-August, from +5.8%
in the corresponding period of 2009.

Going forward, inflation is expected to increase at a faster pace due to the Government’s move to raise fuel and
sugar prices with effect from 16 July in order to gradually reduce its subsidies. Our estimates showed that the increase
of about 3.0% in fuel prices and 17% increase in sugar price in July would add 0.2 percentage point and 0.08 percentage
point respectively to the CPI. This, together with some spill-over effect, will likely push up the CPI in 2H 2010 to around
2.6% yoy, from +1.4% recorded in the 1H, bringing the full-year inflation rate to an average of 2.0% for 2010, from
+0.6% in 2009. Further out, the Government indicated that it would reduce its subsidies once every six months. A
moderation in demand as the economy softens, however, will provide some mitigation. On balance, we expect inflation
to trend up to an average of 2.8% in 2011.

Although the change in administrative pricing will lead to higher inflationary pressure, we believe Bank Negara Malaysia
(BNM) will unlikely act on it. As it stands, its interest rate hikes thus far were geared towards normalising monetary
conditions in the economy rather than controlling inflation. Indeed, we believe the Central Bank is likely to have done
with its interest rate hikes this year, after raising it by a total of 75 basis points in three meetings and the overnight
policy rate (OPR) will likely stay at 2.75% until end-2010. Already, BNM took a pause and maintained its OPR on 2
September. Further out, we believe the Central Bank will likely resume with its policy normalisation and the OPR will
likely be raised by 50-75 basis points in 1H 2011 to bring it to a more neutral level of 3.25-3.50% by mid-2011.

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 22 September 2010

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