IN 2022, stronger economic recovery prospects and upside inflation risk amid the US Federal Reserve’s aggressive monetary tightening had prompted Bank Negara Malaysia (BNM) to hike its overnight policy rate (OPR) by 100 basis points (bps) over four consecutive meetings.
This brought BNM’s overnight policy rate to 2.75%, normalising it closer to 3.00%-3.25% during the 2011-2019 period.
Following the first Monetary Policy Committee (MPC) meeting on Jan 18-19, the central bank surprises the market by keeping interest rate unchanged at 2.75%.
The pause has stirred expectations that BNM is preparing the market for ending the rate hiking cycle ahead. Is it time for a pause in interest rate hikes? What is the balance of risks between growth and inflation outlook?
During the analysts’ briefing, BNM said that it has “not quite done” with raising interest rates and reiterated that the pause allows it to assess the lag impact of previous rate hikes on the economy which takes about 12-14 months.
There were questionable doubts about the justification for a pause given that there were no material changes in economic assessment of both global and domestic economy compared to previous MCP (Monetary Policy Committee) statement in November 2022 except for the re-opening of China economy which is deemed as a positive catalyst.
In our view, BNM is erring on the conservative side, pending further confirmation of incoming data to see whether the economy is resilient enough to absorb to the previous rate hikes amid the slowing global economy.
The lessening downward pressure on the ringgit due to the US dollar’s weakness on the near ending of the Fed’s rate tightening cycle provided some breathing space to manage the rate hikes.
BNM continues to emphasise that the current OPR level remains accommodative and supportive of economic growth. The statement language left the door open to a continuation of interest rate hikes, depending on the incoming data on domestic growth and inflation.
Rate tightening not over yet
BNM has highlighted potential downside risks to global economy and domestic economic growth (a weaker-than-expected global growth, more aggressive monetary policy tightening in major economies, further escalation of geopolitical conflicts, and re-emergence of significant supply chain disruptions).
It is a “wait and see and data dependent” monetary approach. January’s MPC policy statement and the analysts’ briefing signalling that BNM is not yet close to pausing its interest rate normalisation given the balance of risk to the inflation outlook remains tilted to the upside.
It is clear that it is not yet time for BNM to stop normalising interest rates and it needs more data points with some confirmation on how the economy is doing and also the risk of inflation.
We view the statement and analysts’ briefing’s messages that it is possible for a continuation of interest rate hikes if the following trigger points materialise in the incoming data:
- No severe shocks to domestic economic growth: It is clear that January’s interest rate pause is not triggered by concerns about the growth prospects. BNM maintains positive economic growth outlook in 2023 though GDP growth rate will moderate from the exceptional strong growth level in 2022.
We estimate real GDP to grow by 4.1% in 2023 compared to estimated 8.5% in 2022, reflecting the normalisation of domestic demand growth trend due to high base effect.
BNM does not expect a global recession though the US economy is expected to slip into a mild technical recession while the European economy may turn out to better than expected. China’s economic re-opening is a positive catalyst to the global economy via trade, investment and travel (tourism) spending. Malaysia will stand to benefit from China’s better economic growth, particularly on the revival of Chinese tourists.
Moreover, domestic demand will underpin economic growth amid slowing exports. Sustained gains in labour market and income prospects will support household spending. Tourism-related sectors will continue to expand as well as the realisation of multi-year infrastructure projects will support investment activity.
- Upside risks to domestic inflation outlook in 2023: BNM remains wary about the inflation risk, subjecting to the pace and timing of changes to domestic fuel subsidy rationalisation and price controls as well as global energy and commodity prices development.
We need to be wary about the potential demand pressures emanating from China’s re-opening and recovering demand for goods and services may reignite strong price pressures globally. Surging infections and a temporary labour shortage could increase supply chain disruptions.
Throughout this year, BNM expects both headline and core inflation to moderate but remain at elevated levels amid lingering demand and cost pressures. We expect headline inflation to increase by between 2.8% and 3.3% in 2023 from estimated 3.3% in 2022.
- Budgetary stance of new 2023 Budget which will be re-tabled in Parliament on 24 February 2023: Closely watched is the much talk about subsidies rationalisation due to the limited fiscal space. In addition, given the cost-driven inflation and demand risks, an expansionary fiscal policy can also lead to inflation because of the higher demand in the economy.
BNM may face a difficult communication balancing act in coming months. The challenge is not only how to communicate a temporary pause while domestic economic growth still growing amid inflation risk is still elevated, but also to convince markets that BNM is still assessing the balance of risks between growth and inflation outlook. The central bank is still looking to normalise its interest rate.
We continue to expect the central bank to raise the policy rate by 25-50bps to 3.00%-3.25% in 1H and 2H 2023. We caution that cost of living pressures and high household debt (for stressed borrowers) have restrained the level we think BNM will find it appropriate and prudent to pause. – Jan 26, 2023
Lee Heng Guie is the executive director at Socio-Economic Research Centre (SERC) Malaysia.
The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.
