The State of the Nation: Bank Negara’s monetary policy stance remains a wild card for now

This article first appeared in The Edge Malaysia Weekly, on April 1, 2019 - April 07, 2019.
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IF Bank Negara Malaysia governor Datuk Nor Shamsiah Mohd Yunus was keen to join other central banks such as the European Central Bank, the Bank of Japan and the Reserve Bank of New Zealand at the dovish party, she definitely did not let it show.

At a press conference in conjunction with the release of Bank Negara’s 2018 Annual Report last week, Shamsiah dropped absolutely no hints that a cut to the overnight policy rate (OPR) was imminent.

What the governor did say, however, was that the Monetary Policy Committee (MPC) will return with a data-dependent decision once it has reviewed a confluence of factors in deciding whether to adjust the OPR.

“We will look at both external and internal developments, at how those developments affect the domestic economy, inflation and financing conditions,” she says.

Meanwhile, Socio-Economic Research Centre (SERC) executive director Lee Heng Guie says  the probability of a rate cut will depend on how the Malaysian economy responds to the attendant risks, and the first quarter’s gross domestic product (GDP) performance.

“High-frequency data for global and domestic conditions suggests a moderate pace of expansion ahead. There is an even chance that Bank Negara would deliver a rate cut in May’s MPC meeting given the considerable external uncertainties that could undermine consumer and business sentiments, as well as economic growth,” he tells The Edge.

UOB Malaysia senior economist Julia Goh believes Bank Negara has more flexibility now to loosen monetary policy to support growth since there is no expectation of a rate hike from the US Federal Reserve this year.

“In view of higher downside risks to growth, we expect a 25bp cut in the overnight policy rate to 3% as early as May,” she says in a note to investors last week.

Similar sentiments were echoed by CIMB Research economist Michelle Chia, who says current macro conditions present an opportune window for Bank Negara to adopt easier monetary policies that guard against downside growth risks.

“As such, we revise our end-2019 OPR forecast from 3.25% (no hike) to 3% (25bp cut), which still offers Bank Negara sufficient policy buffer for future deployment. The timing of such a cut is, admittedly, a moving target.

“Bank Negara officials noted that monetary policy will be data dependent, suggesting that a loss of vigour in the economy and financial markets ahead of the next MPC meeting on May 7 could prompt policymakers to spring into action,” she writes in a note to clients.

Mizuho Bank Singapore head of economics and strategy Vishnu Varathan assigns a 40% probability to a rate cut at the next meeting.

“A prime reason for a pause eclipsing the case for a cut is that  Bank Negara will want to observe more data points, though as pointed out, the balance of risks is to the downside.

“What’s more, as pointed out when it hiked by 25bps in January last year, that was not tightening per se, but a calibration, which still left policy setting accommodative.

“That said, all else being equal, the global downturn conspiring with subdued inflation sets the stage for a rate cut to gently navigate the economy through the headwinds,” he says.

However, some quarters believe that Bank Negara would likely stay put on the key rate.

Barclays Bank regional economist Brian Tan says the language in the annual report continues to suggest the central bank has little intention of cutting its policy rate in the near term.

“In particular, Bank Negara emphasised that it still expects both economic growth momentum and underlying consumer price index inflation to sustain. The annual report also noted that while the risks of financial imbalances are expected to remain contained, the Monetary Policy Committee is cognisant of challenges emanating from potential continued volatility in global capital flows,” he tells The Edge.

He adds that in its financial stability and payment systems report, the central bank also still sounded hawkish on financial stability risks, stressing that “we cannot afford to be complacent”.

“Our base case remains for no rate cuts because we think a recovery in commodity-related activities would support our forecast for broadly stable GDP growth of 4.5% this year, moderating from 4.7% in 2018. If GDP growth were to slow closer to 4.3%, the bottom of Bank Negara’s 2019 forecast range, we believe rate cuts would come into focus,” says Tan.

Bank Negara is expecting economic growth to come in between 4.3% and 4.8% this year, lower than the Ministry of Finance’s earlier forecast of 4.9%. This was due to the downward revision in global growth, which was revised from 3.7% to 3.5%, Shamsiah explains.

Lee says it is clear that the balance of risks is tilted towards the downside as indicated in the revision of this year’s GDP estimate. “The materialisation of downside risks from unresolved trade tensions, heightened uncertainties in the global and domestic environment, and prolonged weakness in the commodity-related sectors could further weigh down on growth,” he says.

He adds that while domestic demand continues to be the key driver of economic growth, the estimated domestic demand growth of 4.4% this year is 1.2 percentage points lower than 5.6% last year, with private consumption growth moderating and private investment pacing moderately.

“Hence, a pullback in consumption and investment growth could tilt the GDP growth lower. In addition, banking system loan applications moderated towards end-2018,” Lee says.

 

Not a growth-targeting central bank

At the press conference, Shamsiah also made an interesting observation about the role of the central bank in stimulating economic growth.

“It does not mean that whenever there is an adjustment to the OPR, growth is going to be stronger or slower; we are not a growth-targeting central bank,” she says.

Mizuho’s Vishnu concurs with the governor’s statement targeting central banks.

“Bank Negara is implicitly an inflation-targeting central bank. But above all, and most importantly, [the central bank] sets out to achieve monetary and financial stability for sustained growth.

“The emphasis is on stability and sustainability rather than blindly setting out to achieve a hard growth target,” he says.

Tan, who also agrees with the governor’s statement, says historically, Bank Negara has never been purely focused on economic growth as its monetary policy had also accounted for price stability and financial stability.

“A single-minded focus on boosting growth could drive inflation up and fuel a build-up of financial imbalances,” he says.

 

Does Malaysia need a rate cut?

Year to date, the ringgit has appreciated 1.2% against the US dollar to 4.0835 last Friday. A general perception is that a rate cut could depreciate the ringgit. However, Vishnu says this is not necessarily the case.

“Interest rate differentials suggest that, all else being equal, a rate cut should soften the ringgit. But this is often too simplistic and dynamics are far more complex.

“The fact is oil prices have a much larger bearing on the ringgit. Also, a Fed that is turning dovish more quickly — as are regional central banks — could also diminish the rate cut impact on the ringgit,” he says.

The country’s household debt to GDP level remains elevated, though it moderated slightly to 83% last year from 83.8% in 2017.

“A small step in interest rate cut helps to boost consumer and investor sentiment as it provides some relief on debt servicing and lowers lending cost for both consumers and businesses,” says SERC’s Lee.

Meanwhile, reports have emerged on potential deflation concerns for Malaysia, given two consecutive months of price contraction. Shamsiah , however, strongly disagreed with this notion.

“The data speaks for itself. If you look at the CPI basket, more than half of the items are experiencing price increases, so that does not mean a broad-based decline or deflation.

“So when you talk about deflation, you are talking about a broad-based decline in prices, such that the demand conditions have collapsed and firms would have to lower prices in order to attract demand. We are not seeing that kind of conditions.

“The negative inflation is being driven by the [drop] in fuel prices,” she says.

Bank Negara is expecting headline inflation to average between 0.7% and 1.7% this year.

 

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