IN 2022, stronger economic recovery prospects and upside inflation risk amid the Federal Reserve’s (Fed) aggressive monetary tightening prompted Bank Negara to hike its overnight policy rate (OPR) by 100 basis points (bps) over four consecutive meetings.
This brought Bank Negara’s OPR to 2.75%, normalising it closer to 3% to 3.25% during the period 2011-2019.
Following the first Monetary Policy Committee (MPC) meeting on Jan 18-19, 2023, Bank Negara surprised the market by keeping the interest rate unchanged at 2.75%.
The pause has stirred expectations that the central bank 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 the inflation outlook?
During the analysts’ briefing, Bank Negara said that it is “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 to 14 months.
There were questionable doubts about the justification for a pause, given that there were no material changes in economic assessment of both the global and domestic economy compared to the previous MPC statement in November 2022, except for the reopening of China’s economy, which is deemed as a positive catalyst.
In our view, Bank Negara 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.
Bank Negara continues to emphasise that the current OPR level remains accommodative and supportive of economic growth.
The statement left the door open to a continuation of interest rate hikes, depending on the incoming data on domestic growth and inflation.
Bank Negara has highlighted potential downside risks to the 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 the re-emergence of significant supply chain disruptions).
Rate tightening not over yet
It is a “wait-and-see and data-dependent” monetary approach.
January’s MPC policy statement and the analysts’ briefing signalling that Bank Negara 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 Bank Negara 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 analyst briefing message 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.
Bank Negara maintains a positive growth outlook in 2023 though the gross domestic product (GDP) growth rate will moderate from the exceptional strong growth level in 2022.
We estimate real GDP to grow 4.1% in 2023 compared to an estimated 8.5% in 2022, reflecting the normalisation of domestic demand growth due to a high base effect.
Bank Negara 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 be better than expected.
China’s economic reopening 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.
Domestic demand will underpin economic growth amid slowing exports. Sustained gains in the 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.
Bank Negara remains wary about the inflation risk, subject to the pace and timing of changes to domestic fuel subsidy rationalisation and price controls, as well as global energy and commodity price developments.
We need to be wary about the potential demand pressures emanating from China’s reopening 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, Bank Negara 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 an estimated 3.3% in 2022.
> The budgetary stance of the new 2023 budget, which will be retabled in Parliament in February 2023.
Closely watched is the much talked 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.
Bank Negara may face a difficult communication balancing act in the coming months.
The challenge is not only how to communicate a temporary pause while domestic economic growth is still growing amid an inflation risk which is still elevated, but also to convince markets that Bank Negara 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 Bank Negara to raise the policy rate by 25-50 bps to 3%-3.25% in the first and second halves of 2023.
We caution that cost of living pressures and high household debt (for stressed borrowers) have restrained the level we think Bank Negara will find it appropriate and prudent to pause.
Lee Heng Guie is Socio-Economic Research Centre executive director. The views expressed here are the writer’s own.