Rates increase expected, but is timing right?

by **Cals** Mon 14 Jul 2014, 02:59

Published: Saturday July 12, 2014 MYT 12:00:00 AM
Updated: Saturday July 12, 2014 MYT 7:39:09 AM
[size=40]Rates increase expected, but is timing right?
BY INTAN FARHANA ZAINUL[/size]
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Bank Negara says going forward, the over all growth momentum is expected to be sustained.

AFTER keeping interest rates low for the past three years to support economic growth, Bank Negara has finally decided that it is the time to “normalise” interest rates.
In response to firm growth prospects and expecting inflationary pressure to continue, the benchmark overnight policy rate (OPR) was raised by 25 basis points (bps) to 3.25% on Thursday.
This is the first hike since May 2011 and the reasons, although not spelled out, were broadly hinted towards containing inflation and curbing rising household debt.
Most economists are unperturbed with the move, as the central bank has hinted of an imminent hike in OPR after the Monetary Policy Committee (MPC) meeting in May.

According to a Bloomberg survey, 15 out of 21 economists estimated a hike.
“Amid firm growth prospects and with inflation remaining above its long-run average, the MPC decided to adjust the degree of monetary accommodation,” Bank Negara says in a statement.
The economy grew by 6.2% year-on-year in the first quarter with private consumption up 7.1% and private investment expanding by 14.1%.
The prolonged period of low interest rates in Malaysia has been supportive on the domestic economy, hence the recent rate hike has sparked the question whether the time is right for a hike amid a recovery in the global economy.
“Despite higher costs of living, stable income growth and favourable labour-market conditions are expected to buoy private consumption growth,” said CIMB Research in a report.
It expects the country’s economic growth to increase to 5.5% this year and 5.2% in 2015.
Bank Negara remained positive on Malaysia’s growth outlook, riding on the back of recovery in exports, robust investment activity and anchored by private consumption.
Financial imbalances
“Going forward, the overall growth momentum is expected to be sustained.
“Exports will continue to benefit from the recovery in the advanced economies and from regional demand. Investment activity is projected to remain robust, led by the private sector,” says Bank Negara.
There are a lot of factors that could derail the recovery in the world’s economy, including a risk in China’s growth slowing and a slower recovery in Europe and the United States.
“We are actually quite surprised that Bank Negara chose to make this measure this month. The fact that the latest normalisation drive would push the ringgit higher and that puzzles us as export momentum may decelerate in the next few months due to waning competitiveness,” says M&A Securities.
Nonetheless, it believes the economy is capable of absorbing the adjustment.
Prior to the 2008-09 Global Financial Crisis, Malaysia’s OPR stood at 3.5%. The country’s OPR was subsequently cut down to as low as 2% to support the domestic economy during the height of the global downturn in early 2009 before being raised gradually to the present level.
Between November 2008 and February 2009, Bank Negara had cut the OPR by 175 basis points in response to the global economic crisis.
“The rise in OPR will likely to improve Malaysia’s attractiveness amongst foreign investors, leading a stronger capital inflows, lower bond yields and appreciating ringgit,” says AllianceDBS Research chief economist Manokaran Mottain in a report.
He says that since the previous MPC meeting in May, the market has been influenced by this expectation.
Year-to-date, the ringgit had rallied to RM3.172 per US dollar on July 9, registering a 2.06% gain. However, at the close yesterday, the ringgit closed lower at RM3.21 against the greenback.
The central bank also highlights that the increase in the OPR is to ease the risk of financial imbalances, which may effect the economy’s growth prospect.
“At the new level of the OPR, the stance of the monetary policy remains supportive of the economy,” Bank Negara says.
The OPR is an overnight interest rate set by Bank Negara. It is the interest rate at which a bank lends to another bank.
A rate hike would have an impact on businesses and consumers, as changes in the OPR would be passed on through changes in the base lending rate (BLR).
Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz was reported as saying that signs of financial imbalances would also factor into policy decisions, because a prolonged period of accommodation could encourage investors to misprice risk and misallocate resources.
“Higher interest rates should help to ensure a positive real rate of return for deposit savings and deter households from turning to riskier investments,” says CIMB Research.
The low interest rate environment has resulted in rising household debt level, which reached a record of 86.8% of gross domestic product at the end of last year.
“Although the increase in the OPR will likely have some impact on consumer spending and business activities, it will help to moderate the increase in prices,” says RHB Research Institute.
It expects inflation to moderate but to remain high, hovering above 3%.
Most economists are expecting OPR to remain unchanged at 3.25% for the rest of the year, although price pressures are likely to remain.
They say Bank Negara may resume its interest rate normalisation only next year.
“The price pressure is likely to remain, in view of further subsidy rationalisation (another round of fuel-price hike this year),” CIMB Research says.
Muted impact
“Another 25bps hike will crimp domestic demand,” Manokaran opines, adding that there are other measures that may be taken if household debt continues to grow at a worrying pace.
Malaysia is the first country in the South-East Asia to increase its benchmark rate on the back of improve confidence in exports growth and robust investment activity.
According to CIMB Research, Malaysia’s equity market has already priced in an interest rate hike following the May MPC meeting.
The research house says while the is negative for equities, the impact on the stock market should be muted as the increase is minimal.
“Rate hikes are negative for cyclical sectors such as property and auto, as well as consumer stocks due to lower disposable income,” it says.
In the property sector, rising interest rates would increase mortgage payment and reduce affordability.
However, CIMB opines that the impact of a gradual rise in interest rates will be mitigated as the key drivers of property demand are the overall economy and the stock market.
“But the overall impact should be muted as net gearing for corporate Malaysia is less than 10%,” it adds.
CIMB notes that the banking sector will benefit from the rate hike due to a positive re-pricing gap between lending and deposit rates.
“We estimate that a 25bps rise in OPR could enhance banks’ earnings by 1% to 2%.
“This would outweigh any slowdown in loan growth in an environment of higher interest rates, while asset quality is expected to be unaffected,” it says.