Flash Notes-Malaysia: BNM holds rates with a more dovish stance

As expected, Bank Negara Malaysia (BNM) kept its Overnight Policy Rate (OPR) unchanged at 3.25% today. All 21analysts surveyed by Bloomberg (including us) expected rates to stay on hold. The OPR has been kept unchanged overthe last five meetings since September 2014.

    BNM held a dovish stance amid heightened risks to global growth and financial conditions. BNM stated that “therecovery in global growth has become vulnerable to increased downside risks. International financial markets have alsobecome more volatile following increased concerns over developments in Europe and continued policy uncertainties inseveral major advanced countries. There are also downside risks to growth in the major Asian economies.” On the domestic front, BNM maintained that growth prospects remain steady with domestic demand as the key driverof growth. A temporary slowdown in economic activity in the second quarter is expected with the introduction of the Goodsand Services Tax (GST) and weaker export performance. However household consumption will be supported by stablelabor market conditions and sustained wage growth. Investment activity is projected to be driven by capital expenditure inthe manufacturing and services sectors, as well as infrastructure projects.

    Headline inflation is manageable averaging 2% y/y in April and May. For the rest of the year, we expect a gradual uptickin the pace of inflation due to the follow-through of secondary spillover effects from GST, a weaker Ringgit that will inflatethe price of petrol, gas tariff hike this month, and potential hikes in public transportation fares and toll rates. Neverthelessprice pressures will be capped by an environment of weaker local sentiment and domestic demand. Other mitigating factorsinclude no change in electricity tariff in the second half of this year and potentially more zero-rated or GST exempted itemsto be announced in the coming budget. We reaffirm our average inflation outlook of 2.1% in 2015 and 2.7% in 2016 (vs.

    3.1% in 2014).

    BNM added an extra paragraph on recent developments that have affected the Ringgit. BNM reaffirmed that “thereremains ample liquidity in the domestic financial system with continued orderly functioning of the financial and foreignexchange markets. The financial institutions are also operating with strong capital and liquidity buffers. Access to financinghas continued with credit growth remaining at healthy levels. Financial intermediation has therefore continued to supportthe economy.” Recent official comments have asserted that the Ringgit is “grossly undervalued”. The USDMYR overshotthe psychological 3.80 level to a high of 3.84 earlier this week but has stabilised at 3.79 today. The Ringgit is Asia’sweakest performing currency, down 7.5% year-to-date.

    Despite the more dovish statement, we continue to expect no change in the OPR this year. We do not think currenteconomic conditions warrant an interest rate cut at this juncture.

    While the common view is that BNM will resist lowering rates in the face of Ringgit weakness, ultimately we think thatgrowth and inflation considerations will determine the trajectory of Malaysia’s interest rates. Given that risks to the outlookare tilted to the downside, any change in policy stance is more likely to be an easing bias.