Bank Negara Malaysia’s decision last week to hold back another increase in the overnight policy rate (OPR) in view of a slowdown in the economy this year seems to have added an ele­ment of uncertainty to the projections of economists and capital market players.

The central bank’s surprise move to keep the OPR at 2.75% has sparked talk that a dovish approach is on the cards if the global economy weakens at a faster pace than expected.

Dr Yeah Kim Leng, professor of economics at Sunway University, says 2.75% could be the terminal rate for this year if global economic conditions worsen.

“With global growth uncertainty — and if it turns out to be worse than expected — the terminal rate could remain where we are now if inflation remains stable,” he tells The Edge.

“The pause is conditioned by the central bank’s increased worries about the impact of a global slowdown, especially potentially a deeper-than-expected downturn. That will have a greater knock-on impact on the Malaysian economy, given its openness to trade and investment. Whether the central bank will resume normalisation will be driven by data.”

A pause is also possible in the event of stagflation — high inflation with growth stagnant, Yeah says. Having said that, Malaysia’s headline inflation for December 2022 continued to ease to a six-month low of 3.8%, after peaking in 3Q2022. On a full-year basis, inflation came in at 3.3% against 2.5% in 2021.

DBS Group Research says Bank Negara is set for a prolonged pause, as it appears to place a higher emphasis on the country’s softer growth outlook in 2023 over elevated inflation levels, coupled with a shift in guidance.

“We sense a higher reluctance towards additional hikes … The re-tabling of Budget 2023 on Feb 24 would also be a key input in Bank Negara’s policy assessment, beyond growth performance and uncertainties.

“Potential shifts from the Prime Minister Anwar Ibrahim-led government’s review of the subsidies programmes to contain spending and high government debt might spark upside inflation risks, bringing back the debate of monetary tightening to anchor price expectations,” it says in a note last Friday.

There were material changes in the latest monetary policy statement, with Bank Negara dropping certain phrases, such as “the MPC (Monetary Policy Committee) is not on any pre-set course” and “any adjustments to the monetary policy settings going forward would be done in a measured and gradual manner”.

With that, UOB Global Economics & Markets Research sees Bank Negara nearing the end of its interest rate hike cycle, expecting it to dial down the rate hikes by 25 basis points to 3% by mid-2023.

The central bank said further normalisation to the degree of monetary policy accommodation would be informed by the evolving conditions and their implications for domestic inflation and the growth outlook.

The latest decision allows the MPC to assess the impact of the cumulative past OPR adjustments, given the lag effects of monetary policy on the economy, it added.

“At the current OPR level, the stance of monetary policy remains accommodative and supportive of economic growth. The MPC will continue to calibrate the monetary policy settings that balance the risks to domestic inflation and sustainable growth.”

Of the 18 economists surveyed by Bloom­berg, only Nomura predicted correctly that Bank Negara would maintain the key interest rate at 2.75%. Last year, the OPR was raised by a cumulative 100bps from the record low of 1.75%.

Nevertheless, it is worth noting that Maybank’s fixed income research had talked about a potential pause in the OPR.

Just a temporary pause?

Citi Research has a different view, saying this is an “intermittent” pause, allowing for more time to assess the impact of earlier hikes, changes to the balance of risks from policy adjustments in the budget as well as China’s reopening.

“With core inflation still seen elevated (despite moderating) and risks to the upside, we expect at least another 25bps hike in March and another 25bps in May, with further hikes in 2H2023 possible,” it says in a note last Friday.

Citi Research estimates that economic growth will moderate to 4% in 2023 on base effects and external headwinds.

CGS-CIMB Research points out that this is not the first time Bank Negara has paused rate hikes mid-cycle.

“After a 150bps cut amid the global financial crisis in 2008, the central bank hiked rates by 25bps thrice in 2010 to 2.75%, but paused for seven months amid concerns over slowing exports before raising rates again by 25bps twice thereafter.

“The current situation bears an uncanny resemblance to the events in 2010, with domestic demand projected to show resilience amid an environment of weaker external demand,” the research house says in a note last Thursday.

CGS-CIMB believes the direction of the monetary policy remains on the upward trend, but the next hikes are likely to happen only in 2H2023.

“Budget 2023 may not give much clarity in terms of decisions over new taxes and subsidies, as the government may hold off negative announcements until the state elections (to be held by June 2023 at the latest). In addition, the weaker global environment over the next few months will shift Bank Negara’s narrative to be more dovish until the global economy starts to turn around, in our view. As such, we still maintain our outlook for end-2023 OPR of 3.25%, with a pause in 1H2023 and a 50bps hike in 2H2023,” it says.

Similarly, Fitch Solutions maintains its forecast that the OPR will be increased to a terminal rate of 3.25% over the coming months.

“We believe above-target inflation and negative real interest rates will prompt further tightening by the central bank to safeguard macroeconomic stability. Admittedly, we are now expecting headline inflation to moderate slightly to an average of 2.9% in 2023 (down from 3.1% previously), versus an average of 3.3% from January to November 2022.

“The key takeaway, however, is that price pressures are likely to remain higher than the 2016 to 2021 average of 1.5%, and Bank Negara’s target of a 2.2% to 3.2% forecast range for most of 1H2023,” it says.

OCBC Treasury Research says Bank Negara is largely done with its rate hike cycle.

“Its decision to pause strikes is especially interesting because, even as it had highlighted growth concerns before, it was similarly concerned about inflation risks.

“On balance, by essentially declaring that it is done with rate hikes for now, it has signalled that growth concerns are starting to manifest more strongly, just as inflation risk has relatively subsided, perhaps with a view that the government fuel and food subsidy regime is likely to stay broadly in place,” says economist Wellian Wiranto in the bank’s Jan 19 note to clients.

He ends the report by saying that those looking for central banks on a rate upcycle should look anywhere but at Bank Negara and Bank Indonesia, which raised rates by 25bps to 5.75%, also on Thursday. “These two are very much ready to say bye-bye to the uptick cycle,” he quips.

The next MPC meeting is scheduled for March 8 and 9. There are six MPC meetings annually to decide on the appropriate level of the policy interest rate.

In the US, a Federal Reserve pivot is already much anticipated, even though the current federal funds rate of 4.25% to 4.5% is still considerably lower than the projected terminal rate of up to 5.1%.

According to a Reuters poll, the Fed is expected to end its tightening cycle after a 25bps hike at each of its next two policy meetings. In total, the Fed raised rates by 425bps last year.

Monetary policy divergence adds to uncertainty

At home, the upcoming economic data will be closely monitored in view of Bank Negara’s increased emphasis on growth prospects over inflation. Sunway University’s Yeah expects gross domestic product to expand slower at 3.5% to 4% this year, having factored in the accelerated pace of decline in global growth and other external risks. The local economy is forecast to grow strongly at 6.5% to 7% for 2022.

He says: “The Western economies have not ended their rate hikes yet. They are just tapering off their rate increases. That’s another uncertainty over monetary policy divergence between developed and developing countries. There is no doubt that the global economy is experiencing very uneven growth.”

He adds that inflation is very much dependent on the magnitude and pace of the fuel subsidy rationalisation. “If it is aggressive, then, of course, we will continue to feel the increase in inflation. My expectation is that it will be 3% to 3.5% for 2023, with the upside risk because of the subsidy rationalisation that Malaysia has to undertake.”

He believes, however, that the rolling back of subsidies will be more gradual to ensure that public backlash is minimal ahead of a few state elections this year.

On another note, the persistent weakening of the US dollar bodes well for a basket of major currencies, including the ringgit, which has strengthened 2.7% since early this year. At 5pm last Friday, the local unit was trading higher at 4.2855 against the greenback, despite Bank Negara’s maintaining of the OPR at 2.75%.

“With the rate hike pause, the economy may be on a stronger footing for growth. That is the kind of growth premium attached to the currency,” Yeah says.

Meanwhile, DBS notes that concerns on the ringgit’s volatility were omitted, following the currency’s appreciation from late November last year amid peak US dollar and a much reduced domestic political risk premium.

Last year, the ringgit weakened by about 6% against the US dollar.

This article was first published in The Edge Markets, 30 January 2023.