High inflation likely to affect interest rates


  • Business
  • Saturday, 01 Jul 2006

THE recent data released by the Statistics Department suggests that the impact of the recent hike in fuel prices on inflation has slowly diminished.  

The inflation rate, as measured by the Consumer Price Index (CPI), moderated to 3.9% from May last year. This came in lower-than-market consensus of 4.1%. The CPI reached its peak for the first five months of the year at 4.8% in March before moderating to 4.6% in April.  

The lower inflation rate was due to the moderate impact of the cost of transport on the total CPI items, which dropped to 12.4% from 16.9% in April. It was at a high of 18.1% in March.  

There was a buying spree following the release of the inflation data. The market welcomed the lower-than-expected inflation rate because it had perceived that inflationary pressure had subsided and there was less pressure for Bank Negara to hike up interest rates.  

However, the sentiment was short-lived as the market turned bearish on fears of higher global interest rates following rumours of aggressive monetary tightening by the US Federal Reserve (Fed). It was perceived that this might put pressure on Bank Negara to hike the overnight policy rate (OPR). However, the Fed only raised its interest rates by 25 basis points to 5.25% in an announcement released late Thursday. 

Most economists are expecting the inflation rate in the coming months to remain on the upside following the hike in electricity tariffs effective June. This is because businesses will likely pass on their higher electricity costs to consumers in order to mitigate their own increase in production costs.  

Meanwhile, investors are sensitive to inflation data because it eats away their investment returns. Expectations of high inflation rates in the economy will generally cause selling pressure on bonds. This is because higher inflation rates will normally be followed by increase in interest rates.  

For the record, high interest rates will push up bond yields and pull down their prices because bond yields and prices are inversely related. The market is expecting Bank Negara to raise the OPR during its policy meeting this month to mitigate inflationary pressures in order to maintain growth stability. 

Benchmark bond yields ended higher on Thursday. The three- and five-year Malaysian Government Securities (MGS) rose nine to 10 basis points to close at 4.50% and 4.59% respectively, while the 10-year MGS rose by only five basis points from the previous week’s level. Reflecting the movements, the spread between short- and long-term yields narrowed from 62 basis points to 57 basis points.  

On the short-term government securities, there was buying interest as rates slipped five to 10 basis points on the two- to three-month tenure. The two-month was dealt at 3.25%-3.39% while the three-month at 3.38%-3.42%. 

Total volume of all bonds traded in the secondary market dropped to RM3.9bil from RM5.4bil last week. Of this, trading volume in sovereign bonds dropped from RM3.7bil to RM2.8bil. In contrast, trading volume in the private debt securities (PDS) increased from RM1.7bil to RM2.2bil.  

But while trade flow remained on the short- to long-term AAA and AA segment of the PDS market, there was some negative news on the PDS rating front in general for the past two weeks. In fact, the long-term ratings of Ambang Sentosa class B and C bonds were downgraded from BBB+ID and BBBID to CID, following insufficient funds in the designated accounts to meet a principal redemption due this month.  

Stenta Films (M) Sdn Bhd’s Murabahah paper has been placed on a rating watch with a negative outlook following its intention to request for a further moratorium on its principal repayment for another two years to September 2008, while Aegis One Bhd’s collateralised loan obligation bonds is also under a rating watch with a negative outlook with possible downgrades following an increas in weighted average ratings and failure to pay interest of the obligors on their loans. 

  • The writer is general manager, economic and capital market division.  

    For reports from the Statistics Department click here

     

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