This article first appeared in The Edge Malaysia Weekly on June 20, 2022 - June 26, 2022

IF Bank Negara Malaysia’s eight-member monetary policy committee (MPC) raises the overnight policy rate (OPR) by 25 basis points (bps) at its next scheduled meeting on July 6, it will mark its first back-to-back increase since mid-2010, when interest rates were normalised following the recovery from the 2008 global financial crisis. It will not be the first central bank to do so.

Compared with just a month ago, more economists now (at the time of writing) reckon that a 25bps hike will happen in July, but many still think a pause is possible in July ahead of the Hari Raya Aidiladha celebrations. In any case, at least one more rate increase (if not two) is expected to take place by the conclusion of the Sept 8 meeting to bring the OPR to at least 2.25% (if not 2.5%), consensus data show.

“Our house has also shifted expectations for Bank Negara to frontload rate hikes. We now expect the central bank to tighten 25bps in July and another 25bps [to 2.5%] before year end. For 2023, [we see] another 50bps hike in total to bring the OPR to 3%,” experts at Maybank Investment Bank Research write in a June 16 note.

For the record, economists who correctly predicted that the MPC would begin normalising rates with a 25bps increase in May were in the minority. Those who think a cumulative 50bps hike will happen via two increases at the remaining three MPC meetings this year to bring the OPR to 2.5% by Nov 3 (the last scheduled MPC meeting for 2022) were also in the minority at the time of writing.

Despite the outsized US Federal Reserve hike, no one expects a 50bps hike to happen at one go just yet, with the OPR only expected to rise closer to 3% by the middle of 2023. Bank Negara governor Tan Sri Nor Shamsiah Mohd Yunus has repeatedly said that any adjustment to the OPR will be “measured and gradual to support sustainable economic growth, while ensuring price stability”.

It remains to be seen if more economists will revise their expectations in the coming fortnight after the Fed on June 15 began shrinking its US$9 trillion balance sheet (quantitative tightening), made its most aggressive rate hike since 1994 (+75bps) to bring its benchmark funds rate to a range of between 1.5% and 1.75%, and guided the possibility of another 50bps or 75bps hike when the rate setters next meet on July 27 — if data show US inflation hasn’t been tamed.

What’s more, compared to the year-end terminal rate (equilibrium) of about 2% in mid-March, the Federal Open Market Committee (FOMC) “dot plot” now shows rates ending the year closer to 3.5% (3.4%) and rising nearer to 4% (3.8%) in 2023.

“From a local rates strategy perspective, we think the hurdle is actually not high for the first few rate hikes by Bank Negara to [between] 2.5% and 2.75%. But it will likely face a higher bar to go further due to the growing external macro headwinds,” says Winson Phoon, head of fixed income research at Maybank Investment Banking Group in Singapore.

While Bank Negara only started raising interest rates in May, the ringgit rate curves “have already risen significantly in tandem with the hawkish repricing in the US rate markets”, says Phoon. As Malaysian Government Securities (MGS) yields “have fully priced in OPR increases to 3.25%”, he reckons that another two to three rate hikes of 25bps each “may not matter much to bond yields, and US rate volatility has been and will remain the main driver”.

Yields for the benchmark 10-year MGS (3.58% coupon), which were at 3.67% at end-February before the Malaysian bond market saw (in March) its first foreign net outflow since November 2021, had risen to 3.85% by end-March and 4.38% by end-April before retracing to 4.17% at end-May, according to Bank Negara data. Closing at 4.36% on June 16, trading yields had a 236bps gap against the OPR and a 108bps spread over the 10-year US Treasury yields that were at 3.28% at the time of writing.

“While MGS yields have adjusted quickly, the impact is confined to issuers and investors of Malaysian government debt securities. By contrast, an OPR change would affect bank lending and deposit rates, with far-reaching consequences for consumption and investment activities in the economy, given the dominance of banks in the country’s financial system,” explains Dr Yeah Kim Leng, professor of economics at Sunway University Business School.

Bank Negara’s rate decision will (as it says) be “data dependent”. Pundits who noted that the central bank’s rate hike in May “had also come during a period of ringgit weakness”, however, think pressure on the ringgit would further mount if Bank Negara is seen as lagging behind monetary normalisation as more central banks raise interest rates.

“If raising rates means Bank Negara is confident of a firmer growth trajectory, not doing so could be read [negatively],” one observer reckons.

Year to date, the ringgit has weakened 5.5% against the US dollar (4.402) and 2.9% against the Singapore dollar (3.1766), whose government fights inflation with its currency strength.

With more than 40 central banks around the world already lifting interest rates, it is little wonder that experts say the days of zero rates are numbered even though there remain significant headwinds to global growth. On June 16, right after the Fed hike, the Swiss National Bank surprised the market with its first rate hike in 15 years (+50bps to -0.25%). The Bank of England raised interest rates by 25bps to 1.25% while Taiwan’s central bank raised its key policy rate by 12.5bps to 1.5% (after a 25bps hike from a historic low of 1.125% in March). The European Central Bank, which called an emergency meeting on June 15 to discuss market conditions, is widely expected to raise interest rates at its next scheduled monetary policy meeting on July 21.

The Bank of Japan, however, on June 17 kept its policy rate at zero, sending the yen lower against the US dollar despite a rare statement that added “foreign exchange rates” to a list of risks requiring the bank’s attention. Ahead of the Fed rate hike, China’s central bank had kept interest rates for one-year medium-term lending facility (MLF) loans unchanged at 2.85% for a fifth month, while Hong Kong — which had more than US$460 billion in foreign currency reserves at end-May — reportedly spent more money to maintain its currency peg to the US dollar that has been in place since 1983.

Before a 25bps cut to 3% in May 2019, Malaysia’s OPR had been at 3.25% since January 2018. It was only after four back-to-back cuts totalling 125bps between January and July 2020 that the OPR fell to a record low of 1.75%, where it remained for about 22 months before some “excess accommodation” was removed on May 11. Bank Negara’s first rate hike since January 2018 came two days ahead of a stronger-than-expected 1Q2022 GDP growth reading of 5% year on year, allowing it to affirm the official GDP growth target of 5.3% to 6.3% for this year.

While Nor Shamsiah declined to say whether the MPC was looking at a terminal rate of 3% by mid-2023 when asked to comment on May 13, she did say it was “very important” for monetary policy be recalibrated “carefully now to avoid having to be aggressive down the road, which is the case for some central banks that are coming out from very low rates”.

In other words, Bank Negara does not want to have to play catchup down the road if the data points show that the economy no longer needs the current level of monetary accommodation.

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