Bank Negara Malaysia Report Monetary policy "not the best policy tool" to manage inflation

by **Cals** Wed 19 Mar 2014, 22:14

Bank Negara Malaysia Report Monetary policy "not the best policy tool" to manage inflation

Business & Markets 2014

Written by Chong Jin Hun of theedgemalaysia.com

Wednesday, 19 March 2014 18:01

KUALA LUMPUR (Mar 19): Monetary policy via interest rate adjustments is "not the best policy tool" to manage the expected rise in domestic inflation this year according to Bank Negara Malaysia (BNM).

This is because prices are seen rising on cost-push instead of demand-pull factors, BNM said in its latest annual report.

"Given the nature of the factors behind the increase in inflation, monetary policy is not the best policy tool to manage the situation. Being a demand-management tool, there is less reliance on monetary policy to deal with cost-push inflationary pressures," BNM said.

This being the case, BNM said it would rely more on other policies, such as measures to expand domestic capacity, improve the distribution channels and promote market efficiency and competitiveness.

BNM expects Malaysia's headline inflation to average between 3% and 4% in 2014 compared with 2.1% in 2013, mainly on domestic cost factors.

"The higher cost pressures will be partly contained by the subdued external price pressures, continued expansion in domestic capacity and the more moderate rate of expansion in domestic demand.

"There is, however, a risk that higher global commodity prices and stronger-than-expected demand conditions could put an upward pressure on inflation," said BNM which maintained the overnight policy rate at 3.00% at its latest monetary policy committee meeting.

According to BNM's annual report, rising inflationary expectation and excessive wage increase, should they occur, would also create upside risks to inflation.

However, BNM sees these risks as being contained for now.

Nonetheless, it warned that higher cost-push inflation might lead to inflation expectation "becoming unanchored".

BNM said this might result in wage growth which was not consistent with productivity expansion.

Should this happened, BNM said it might create conditions for a more significant increase in inflation.

Mindful of these risks, BNM said its monetary surveillance would stay focused on identifying signs that inflation was becoming more pervasive and persistent where a monetary policy response would become more appropriate.

"Given the prolonged period of relatively low international and domestic interest rates, such a situation could encourage excessive risk-taking.

"The consequent build-up of excessive leverage and asset price misalignment could undermine macroeconomic and financial stability should these imbalances unwind in a disorderly manner.

"To the extent that such excessive risk-taking behaviour or asset price escalations occur within specific segments of the economy, other targeted policy instruments such as macroprudential measures would be deployed to address the risks.

"Such measures are, however, complementary in nature and not a substitute for interest rate policy," BNM said.