Bank Negara’s puzzling pre-emptive move to cut OPR

By Ranjit Singh

BANK Negara Malaysia’s (BNM) decision to cut the Overnight Policy Rate (OPR) by 25 basis points to 2.75% in its Monetary Policy Committee (MPC) meeting on Jan 22 caught the market by surprise and raises the question of whether it will increase or lower uncertainty moving forward.

Ahead of the release of the fourth-quarter GDP (gross domestic product – sum of goods and services produced in the economy) figures, BNM seems to be already signalling that the numbers would not be great.

In its statement, the MPC had stated that one of the most cogent reasons for the move was as  a “pre-emptive” measure to contain heightened uncertainty on the global front.

However, one may argue that the global economy was turning the corner with the signing of Phase 1 of the trade agreement between the US and China. The warmer trade relations between the two biggest economies in the world would translate to a higher volume of global trade, and this would be positive for an open economy such as Malaysia.

BNM’s monetary policy easing points to the central bank signalling concerns about the outlook for economic growth, and resorting to lower interest rates to stave off a downturn.

Central banks often resort to lower interest rates in environments like this in order to boost money supply in the economy, stoke demand and provide an impetus to growth.

The question is whether the cut in the OPR was warranted, given that the economy was chugging along fine and with an upward bias due to better trade relations between the US and China. Malaysia is currently having its lowest interest rate regime in a period of nine years.

The last time BNM cut rates was in May 2019, and empirical evidence suggests that it had done little to stimulate growth. Would another cut do any better? Post the OPR cut in May 2019, loan growth in the banking sector was tepid even with the lower interest regime.

After the announcement of the OPR cut, yields on Malaysian Government Securities (MGS) shed about 10bps to 13bps compared to the previous day.  Yields on both the three-year and 10-year MGS settled at their new multi-year lows of 2.93% and 3.18%.

It is anticipated that BNM would apply the brakes on further rate cuts for the year unless the global economic scenario changes drastically or domestic macroeconomic weaknesses become more pronounced. Yield on the 10-year MGS is expected to be in the range of 3%-3.5% in 1H20.

BNM’s concern over the prospects of the global and domestic economy is reflected in its latest statement. Specifically, four global “downside risks” were cited (uncertainty in trade negotiations, geopolitical risks, weaker growth of major trade partners, and heightened financial market volatility) compared to last November’s statement that underlined only two downside risks (uncertainties in global economic and financial conditions).

Domestically, it stated two “downside risks” in the latest statement (weakness in commodity-related sectors and delays in the implementation of projects) compared to only one in the prior statement (weakness in commodity-related sectors).

Will the OPR cut send the wrong signal for the Malaysian economy? Rate cuts are associated with a slowing economy and the GDP is hugely dependent on domestic consumption. The public may cut down on spending as the outlook for the economy is not so bright and this will have a telling effect on economic growth and its prospects.

BNM should not have cut interest rates until there were clearer indicators of the economy’s direction. The move could backfire if consumption is held back on account of a moribund economy going forward.  – Jan 23, 2020

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