“Malaysia’s central bank need not follow suit as monetary policy is independently determined by domestic growth and financial conditions.” - Dr Yeah Kim Leng
PETALING JAYA: The US Federal Reserve’s (Fed) policy stance is a clear signal it remains focused on fighting inflation and will leave it to the markets and other central banks to deal with the fallout.
Central banks of Indonesia and the Philippines raised their benchmark rates by 50 basis points (bps) yesterday to fight inflationary pressures building up in their respective economies and defend their currencies.
Some analysts believe Bank Negara will opt to keep its benchmark overnight policy rate (OPR) unchanged at 2.5% in November as inflation remains manageable.
“Malaysia’s central bank need not follow suit as monetary policy is independently determined by domestic growth and financial conditions. Bank Negara has raised the OPR more gradually by a cumulative 75 bps over three meetings to 2.5% given the manageable rise in inflation while allowing growth to solidify.
“It may take a pause in the final meeting of the year in November but the likelihood of a hike remains given the economy’s growth momentum is likely to continue in the third quarter (3Q) following the sterling 8.9% expansion in the 2Q”, Sunway University professor of economics Dr Yeah Kim Leng told StarBiz.
He added that another 25 bps rise in the OPR to 2.75% will bring the benchmark interest rate closer to the pre-pandemic level of 3.25%.
Kenanga Research, in line with consensus views, said the prospects of GDP growth for the 3Q will remain high at 8.8% (2Q: 8.9%) and inflation at 4.6% (2Q: 2.8%), and that would allow Bank Negara to maintain its hawkish tilt and raise its OPR by 25 bps at its final Monetary Policy Meeting in November this year.
With inflation continuing to persist above 8% in August, the Fed hiked interest rates by another 75 bps on Wednesday, taking the upper end of the Fed funds target rate to 3.25%.
The hike in US interest rates favoured the dollar and saw the ringgit edge down to a fresh 24-year low of RM4.56.45 yesterday against the greenback, while investors sold off in the market to send the FBM KLCI down eight points to 1,439 points.
Crude palm oil futures prices fell RM58 a tonne to RM3,829 as fears of a global recession hit demand expectations following the hawkish tone of Fed chairman Jerome Powell.
He said inflation remained stubborn in the American economy and would take some time to bring it down while indicating he was willing to live with below-trend economic growth in order to do that.
Powell indicated the Fed will likely raise the fund rate by another 75 bps in November and 50 bps in December while undertaking quantitative tightening at the same time to drain liquidity from the economy and markets.
This combination, analysts say, would ensure the US dollar remains strong in the immediate future at the expense of currencies like the ringgit.
“The aggressive monetary tightening by the Fed, complemented with the ongoing external headwinds should now see the local currency trade close to RM4.60 against the dollar. Our initial view of the local currency retracing back towards RM4.45 levels by end of 2022 could be tough.
“Hence, our outlook for the US dollar ringgit pair is now between RM4.45 to RM4.50 levels as the baseline with upside risk at RM4.55 to RM4.60,” AmBank Research stated yesterday.
Currency analysts believe that Asian central banks are under pressure to manage exchange rate vulnerabilities which historically has been an achilles heel for emerging Asia.
The banks are in a difficult position as raising rates will become headwinds to economic growth moving forward and might not help contain currency devaluation against the greenback.
The pace of tightening will need to be more calibrated and economies that are doing well and stand to benefit from reopening of sectors like tourism will be more sheltered from the global headwinds, and be more resilient.
Some think Bank Negara could be prepared to live with a weaker local currency as economic health remains its key concern and the three OPR rate hikes this year did little to reverse the trajectory of the ringgit-US dollar rate.
“We expect Bank Negara will raise it by 25 bps despite earlier rate hikes have done little to slow the ringgit’s weakening,” said country manager of StashAway Malaysia Wong Wai Ken.
As a result, the robo advisor firm with some RM900mil worth of investment in exchange traded funds, expects the ringgit to weaken to RM4.6 as the differential between the Fed funds rate and OPR widens.
The risk free rate differential is at 75 bps now and could rise to 200 bps if the Fed raises its Fed fund rate to 4.25%-4.5% by the end of this year as anticipated.
While the country has seen outflows from the debt market, inflows into the equity market have offset that underpinned by the prospects of a 6% economic growth for this year.
Others believe Bank Negara will adopt a wait and see approach and only raise the OPR next year should inflation remain above target levels.
“Our house view is no more hikes this year but two hikes in 2023 (to 3%). Interest-rate differential of policy rates is not necessarily a major determinant of capital flows. If the global inflation outlook and risk aversion significantly moderates in 2023, Malaysian equities may benefit from net inflows,” said UOB Kay Hian head of research Vincent Khoo.
Yeah, however, expects a pause or ‘pivot’ in the rate cycle in early 2023 once there is certainty of the US and Europe falling into recession as the downturn will likely ease global price pressures and reverse US dollar strength, thereby providing some respite to Malaysia and other emerging countries.
The Fed has overestimated its tightening cycle in the past and is now more hawkish than the market which is expecting the Fed fund rate to hit 4.4% in this tightening cycle while the Fed has signalled it could go to 4.6% by end 2023.
