Rate cut on the horizon

GLOBAL interest rates peaked sometime in the second half of financial year 2024 (2H24), and with key inflation indicators beginning to trend lower, central banks have turned dovish by lowering their benchmark interest rates.

Over the past year, other than Malaysia and Vietnam, most central banks have cut rates, with the Bank of Canada and Reserve Bank of New Zealand (RBNZ) being the most aggressive – each lowering key rates by as much as 225 basis points (bps).

This was followed by the European Central Bank, which cut its benchmark deposit rate by 175 bps to 2.25%.

In the past week alone, RBNZ and the Bank of Korea took further steps to lower rates by 25 bps each.

The accompanying table provides an overview of rate cuts by major central banks since the start of the global rate-cut cycle.

To cut or not to cut

While this poses a dilemma for the US Federal Reserve (Fed), to be fair, the data-dependent Fed has lowered rates by as much as 100 bps so far to between 4.25% and 4.5%.

However, the last cut was in November last year, and since then, the Fed has stood firm – dismissing even calls from the US president to lower rates.

Why?

Firstly, as the Fed is driven by its mandate, the core Personal Consumption Expenditure (PCE), Fed’s preferred inflation measure, of 2.6% recorded in March 2025 is still ahead of its comfort zone.

Secondly, the labour market remains surprisingly resilient despite tariffs and their impact on US consumers and businesses.

Thirdly, the anticipated inflationary effects of tariffs have yet to fully materialise in full force, and the Fed may risk sending the wrong signal if it decides to cut rates now.

Lastly, even if tariffs cause aggregate prices and inflation prints, especially the core PCE, to jump, the Fed is unlikely to react hastily by adjusting the Fed Fund Rate, as doing so could trigger other non-consequential impacts on the fragile US economy.

Cutting rates at a time when inflation is surging – presumedly due to tariffs – and economic growth is slowing, or worse, the economy is going into recession, may turn out to be catastrophic for markets.

As inflation is measured against past periods, be it monthly or yearly, the hike caused by tariffs may be transitory and likely to level off one year down the road.

Nevertheless, if the economic pain is severe, markets may price in a rate cut sooner-than-expected, and the Fed would have no choice but to lower rates to save an ailing economy.

For the Fed, it is more appropriate to cut rates when it feels comfortable, such as due to falling core PCE readings, rather than being forced to act because the economy is going into the reverse gear.

Benign inflation

As can be seen in the table provided, Malaysia, along with Vietnam, stands out as one of the few nations yet to cut benchmark interest rates.

Malaysia’s Consumer Price Index (CPI) up to April 2025 has been modest at just 1.5% year-to-date, with core inflation marginally higher at 1.9% for the first four months.

Bank Negara has maintained its headline inflation forecast for 2025 within a wide range of 2% to 3.5%.

This suggests that the central bank is still expecting inflation for May to December 2025 to average between 2.2% and 4.5%, reflecting a pessimistic outlook.

The higher headline inflation is reflective of the full implementation of subsidy rationalisation, as well as the kicking in of the expanded sales and service tax (SST).

RON95 stays

Prime Minister Datuk Seri Anwar Ibrahim recently stated that the long-awaited subsidy rationalisation involving the widely used RON95 fuel will not be implemented as the government disagrees with the proposal to raise prices.

Nevertheless, the PM highlighted that foreigners and the ultra-rich (defined as the top 5%) must pay market prices.

As a result, the impact on RON95 – which carries a 5.5% weight in the CPI – is expected to be limited.

The knock-on effect on goods and services will also be limited.

This will allow Bank Negara to lower the inflation forecast for the year to not more than 2.5%, as there is still added pressure from the expanded SST and a slight impact from the fuel subsidy rationalisation when implemented in 2H25.

Time to cut OPR

The current consensus is that Malaysia’s economic growth will likely come in below Bank Negara’s forecast of 4.5% to 5.5%, with growth slowing to just 4.1%, according to the median estimates from 28 economists.

The central bank has yet to revise its growth outlook and will likely do so in early 2H25, once the reciprocal tariff for Malaysian exports to the United States is known.

Despite the delayed reaction, markets are already pricing in expectations that growth will slow to just above 4% this year.

Given the slowing economy and benign inflation, Bank Negara has a strong case to lower the overnight policy rate (OPR) by 25 bps in July 2025, followed by another 25 bps cut in September or November, depending on how severely Trump tariffs and weaker external demand affect growth.

The ringgit

At the time of writing, the ringgit was last seen at 4.2400 against the greenback, up 5.3% year-to-date.

The Dollar Index, on the other hand, dropped by approximately 7.9% over the same period, suggesting that the ringgit has outperformed the US dollar not only due to the latter’s weakness, but also of its own strength.

Malaysia’s fixed-income market has benefited from this, offering an attractive combination of currency appreciation and decent yields – drawing RM13.5bil in foreign inflows up to April 2025, including RM10.2bil in April alone.

Even foreign reserves have strengthened, climbing to US$119.1bil as at mid-May 2025, up 2.5% from US$116.2bil as at the end of last year.

Given the ringgit’s outperformance, stronger international reserves, a slowing economy, and benign inflation, the time is ripe to lower the benchmark OPR.