KUALA LUMPUR: In its latest monetary policy statement on Jan 26, Bank Negara Malaysia (BNM) kept the Overnight Policy Rate (OPR) unchanged at 2%, as widely expected, and reiterated the “appropriateness” of the current monetary policy stance against the backdrop of re-emerging inflation, Standard Chartered Global Research said on Feb 1.
However, there was a significant change in its statement which pointed to a more hawkish stance: the central bank highlighted the need “to prevent the build up of financial imbalances that could arise from interest rates being too low for a prolonged period of time”.
Below is the report by the research house
Because BNM initiated its rate-cutting cycle later than most of its regional peers in 2008, we originally believed it would also start raising rates later, ensuring that the recovery was firmly entrenched first.
However, given the improvement in economic conditions and BNM’s hawkish tone, we now believe the central bank may hike rates much sooner than we previously expected.
We emphasise that this should not be seen as beginning of an aggressive hiking cycle, but rather as a normalisation of interest rates to guard against financial imbalances, which could arise as cheap money finds its way into asset markets such as real estate and equities.
BNM’s more hawkish position also reflects its upbeat view of Malaysia’s economic conditions; the central bank brushed aside the possible moderation in global growth in H2-2010. Thus, based on domestic financial conditions, it can afford to focus on normalising monetary policy.
We expect BNM to start raising rates as soon as its next policy meeting on 4 March.
We expect three 25bps hikes this year, taking the OPR to 2.75% by mid-2010.
We expect another 75bps of hikes in 2011, taking the rate back to its previous high of 3.5%.
Since the passing of the Central Bank of Malaysia Act 2009, BNM now convenes the Monetary Policy Committee to set the OPR six times a year, instead of eight times as in previous years.
Visible improvement in economic conditions
Looking back at the depths of the recession in Q4-2008 and Q1-2009, the central bank acted appropriately, in our view, cutting the OPR aggressively by 150bps to the current record low of 2%. Note that when the OPR was first used as BNM’s chief policy instrument in 2004, it was at 2.7%.
We believe an OPR of 2% was appropriate for 2009 given the weak domestic and external environment at the time.
But the worst has passed, and while we still expect the recovery to be gradual and bumpy, 2010 will clearly be different from 2009. The improvement in economic conditions is the most important factor to consider in reviewing the appropriateness of the current monetary policy stance. However, this is not the only consideration.
Pre-empting financial imbalances with little impact on lending
The central bank is wary that if interest rates remain too low for too long in an environment of flush liquidity, low-cost funds will eventually find their way into asset markets like equity and property to seek higher returns, leading to the formation of asset bubbles.
Following the aggressive OPR cuts of late 2008 and early 2009, the base lending rate (BLR) of commercial banks fell from 6.72% to 5.51% and has stayed at that level since March 2009.
However, the average lending rate (ALR) on loans outstanding has continued to fall since March 2009, even as the BLR has remained stable. The ALR fell to a new record low of 4.85% in November 2009 (the latest data available), reflecting BNM concerns that cheap credit may start to find its way into asset markets.
Going forward, Malaysia’s domestic economy is set to benefit from the impact of government stimulus packages and the recovery of global demand.
So even if lending rates were to move up from their current historic low, the impact on lending activity should be minimal. The more important point is that credit remains available to businesses and households.
BNM is normalising interest rates, not tightening
Monetary policy centred on interest rates works with a lag (typically of two to three quarters), so pre-empting financial imbalances would require acting soon.
We also believe that BNM wants to normalise interest rates to suit current economic conditions.
This is unlikely to bring the OPR back to the pre-crisis level of 3.5% this year, in our view.
We now expect the first hike on 4 March 2010, followed by another two 25bps hikes at the 13 May and 8 July policy meetings.
We expect BNM to hold the rate at 2.75% for the rest of 2010 (quite close to the 2.7% level at which the OPR was initially set in 2004). We expect the OPR to remain at this ‘normalised’ level for the remainder of 2010, barring unexpected external shocks.
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