Time for a pause in interest rate hikes?

 

There is a difference between what financial forecasters predict Bank Negara Malaysia (BNM) will do with the overnight policy rate (OPR) and what economic forecasters predict should or could be done.

Financial analysts often look at current data, which actually measures what has already happened. They adapt expectations to past events rather than make forward looking expectations of future events. So, if inflation is currently high or was high in the past they say interest rates must rise today, even though that horse has already bolted.

Often they insist that the OPR is driven by the exchange rate and must rise if the ringgit weakens against the dollar. This normally ignores all other regional currencies and the clear and repeated guidance from BNM that the OPR is not set in response to the exchange rate.

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They also refer too much to international interest rates, especially the Federal Reserve and claim that if interest rates rise to control US inflation, Malaysia must do the same. Whereas we know, price controls and subsidies have been much more effective than interest rates in keeping inflation in Malaysia below our regional peers.

In reality, the BNM mandate is based on domestic considerations namely maintaining the stability of prices and the financial system while promoting sustainable economic growth.

Based on the current data and reasonable projections, headline inflation is slowing and is on a downward trend. Core inflation is elevated but is also likely to slow in coming months.

Maintaining utility tariffs for households and 98% of companies will hold down inflation and many key international cost indicators have fallen. Oil prices are back to levels seen in January last year.

On the other hand economic growth will slow because it was pushed artificially high by pre-election policies last year. Exports will be affected by a slowdown in global demand but this may not be as bad as predicted because China has now opened up. The overall effect will bring growth back to normal sustainable levels.

Based on this we should be headed for a period of lower inflation and sustainable growth in line with the BNM mandate. This offers a chance to pause interest rate rises, which would also be wise given uncertainty in global growth and export demand.

BNM has stated that their policy is to recalibrate or normalise interest rates and they had an opportunity to do that because demand was pushed by pre-election policy. The normal level for interest rates is around 2.75% which is where we are now.

Government spending, for which we will see the full budget in February, should be conservative and the interim mini-budget does not look excessive or inflationary.

Another consideration would be inflationary expectations and whether these are leading to a more broad-based rise in prices across all of the CPI components which affects core inflation.

There is some evidence that this is happening as we see embedded inflationary expectations allowing general price rises but the continuation of price controls and the efforts to address monopolies and increase supply should help moderate this.

A third factor is whether higher rates are biting or not in terms of financial markets. The BNM Financial Stability Review suggested that credit markets have not been affected too much and loan repayments are strong. This might signal room for higher rates in future, if necessary but it is not a reason in itself to raise rates now.

While there may be siren voices calling for higher interest rates, BNM should tie itself to the mast and stick to its mandate. It should be driven by structural economic data, not short-term financial market noise. - FMT

The views expressed are those of the writer and do not necessarily reflect those of MMKtT.