OPR: Up, up and away into 2023

 

ALL eyes were on the last Monetary Policy Committee (MPC) meeting for this year as it decides on the country’s monetary policy under the shadow of the upcoming General Election and rising inflation brought on by ongoing uncertainties in the global economy.

To navigate through these trying times, on Thursday, Bank Negara Malaysia’s (BNM) MPC has decided to increase the overnight policy rate (OPR) by 25 basis points to 2.75 per cent.

The ceiling and floor rates of the corridor of the OPR are correspondingly increased to three percent and 2.5 per cent, respectively.

Based on latest indicators, the MPC explained that Malaysia’s economic activity strengthened further in the third quarter, driven primarily by robust domestic demand.

It also pointed out that headline inflation is likely to have peaked in the third quarter of 2022 (3Q22) and is expected to moderate thereafter, albeit remaining elevated.

According to the Department of Statistics Malaysia (DOSM), Malaysia’s leading index (LI) recorded an increase of four per cent, equivalent of 4.3 points to 111.3 points in August 2022 (August 2021: 107.0 points).

The growth was primarily supported by a gain in the number of housing units approved, real imports of other basic precious & other non-ferrous metals and number of new companies registered and compared to the previous month, the LI returned to a positive growth of 1.6 per cent in August 2022 from a negative two per cent.

In relation to the current economic situation, the Coincident Index (CI) achieved better index at 120.5 points in August 2022. Accordingly, it increased by 9.8 per cent compared to 109.7 points in the same month of the previous year.

“Against the backdrop of continued positive growth prospects for the Malaysian economy, the MPC decided to further adjust the degree of monetary accommodation.

“The adjustment would also pre-emptively manage the risk of excessive demand on price pressures consistent with the recalibration of monetary policy settings that balances the risks to domestic inflation and sustainable growth.

“At the current OPR level, the stance of monetary policy remains accommodative and supportive of economic growth. The MPC is not on any pre-set course, which means that monetary policy decisions will continue to depend on evolving conditions and their implications on the overall outlook to domestic inflation and growth,” BNM explained in a statement.

It also pointed out that any adjustments to the monetary policy settings going forward would continue to be done in a measured and gradual manner, ensuring that monetary policy remains accommodative to support sustainable economic growth in an environment of price stability.

‘Still cautious on performance’

Despite its positive stance on the domestic economy, BNM is cautious on the performance of the global economy as it viewed that it continues to be weighed down by rising cost pressures, tighter global financial conditions, and strict containment measures in China.

“In particular, continued aggressive adjustments in US interest rates and expectations of a higher terminal rate in the US, have contributed to a persistently strong US dollar environment. This has resulted in higher volatility in financial markets, affecting other major and emerging market currencies, including the ringgit.

“Going forward, the global growth outlook will continue to face headwinds from tighter financial conditions amid elevated inflation in major economies and the domestic challenges in China. The growth outlook remains subject to downside risks, including escalation of geopolitical tensions, worsening of domestic headwinds in China and potential energy rationing in Europe,” it said.

Meanwhile, analysts viewed the rate hike as a necessary step to keep inflation risks at bay.

“On the domestic front, the front loading of OPR hikes is necessary to keep inflation risks at bay amidst a resilient economic performance till around 3Q22.

“A slow-down in 1H23 is anticipated as low base effects wear out, external conditions weaken, and much of the tailwinds from loose fiscal and monetary policy dissipate.

“Given that monetary policy operates with a lag, the hurdles for policy rate hikes would be lower during a decent economic recovery phase rather than when a slow-down manifest itself in 1H23,” an economist at RHB Investment Bank Bhd (RHB Investment) said in a report.

It pointed out that robust domestic demand, coupled with negative real interest rates, would continue to fuel the core inflation pressures in the upcoming months.

It also noted that its proprietary model suggests that consumer spending will remain robust in the next few months (albeit at slower momentum) as we see limited risks of a significant deterioration in labour market conditions in 2H22.

“Hence, the demand side pressures on core CPI inflation will likely stay elevated for the remainder of the year. In view of robust price pressures, we maintain our 2022 CPI forecasts at 3.4 per cent YoY, followed by three per cent y-o-y in 2023.

“The possibility of potential adjustments in fuel and food subsidies implies that the peaking of inflation could be delayed to sometime in 2023,” it added.

“The text in BNM’s monetary policy statement was modestly hawkish in our view. The central bank maintained its stance that any adjustments to the monetary policy settings going forward would be done in a measured and gradual manner, while depending on the evolving conditions and their implications on the overall outlook for domestic inflation and growth.

“The adjustment of the OPR in November is intended to pre-emptively manage the risk of excessive demand on price pressures amidst continued positive growth prospects for the Malaysian economy.

“On economic assessment, BNM stayed cautious on the global economic assessment, citing that the global economy continues to be weighed down by rising cost pressures, tighter global financial conditions, and strict containment measures in China,” RHB Investment said.

 

 

In a separate report, OCBC Bank’s analyst Wellian Wiranto viewed the OPR rate hike as “another notch up in its recalibration drive to normalise the policy rate setting”.

“Even as it tacitly warned of the need to manage the risk of excessive demand, however, we see it coming closer to the end of the tightening cycle than before.

“As much as inflation seems to weigh more than growth on the BNM’s mind now, the balance may well shift to the flip side in the coming months given the global uncertainties,” Wellian added.

“Having raised rates to 2.75 per cent now, the runway to continue ratcheting up the OPR further is getting more limited, naturally.

“To us, it is likely to take just one more hike in early next year to three per cent. Thereafter, we think BNM will perch at that level to survey the global landscape more carefully, to assess any need to move further,” he said.

 

 

 

Banking sector to gain from OPR hike

THE banking sector is expected to gain from the OPR increase with the banks’ net interest margin (NIM) set to see a slight upwards gain from this hike.

“Banks typically gain from a rising interest rate environment. From our sensitivity analysis, we estimated that every 25bps OPR hike would expand sector NIM by five to six bps which in turn, bump up earnings forecast by four to five (on a full year basis, without taking into account of potential market-to-market losses and higher defaults); Alliance and BIMB would benefit most while Affin and Public are poised to gain the least,” said the research team at Hong Leong Investment Bank Bhd (HLIB Research).

“Here we assumed a symmetrical 25bps rate increase for both the variable loans and non-CASA deposits while all other factors were held constant. Besides, we used group figures in our analysis; thus, for banks with sizeable overseas business (like Maybank and CIMB), actual gains are likely to be lower than calculations,” it added.

Based on the trends of September 2022’s OPR hike, HLIB Research noted that the base rate (BR) and lending rate (BLR) increased 25bps respectively, in line with the official 25bps uptick.

“While for deposit, rates climbed by a similar quantum where one to 12 months FD jumped 21 to 24bps but savings only ticked up seven bps.

“Looking further back at May 2022’s OPR hike, we saw 2Q22 sector NIM rose five bps sequentially,” it said.

It also noted that the banking sector’s CASA ratio remains high at 31 per cent against pre-pandemic level of 26 per cent.

“Every one per cent CASA ratio reversal would drag sector NIM by 2bps and earnings by 1 per cent, assuming an FD-CASA spread differential of 200bps. From our compilation, Alliance and Maybank saw their CASA ratio escalated up the most (by 10 to 13ppt) compared with their peers (by seven ppt) from 4Q19 to 2Q22 while Affin and BIMB experienced the least built-up (by two to three ppt).

“However, if a full CASA reversion scenario plays out, it will neutralize gains from 75bps OPR hike. So far, BNM has raised OPR by 100bps against a total 125bps reduction during the Covid-19 pandemic era.

“This suggests room for lesser rate hikes going forward, hurting NIM if CASA consumption happens later on and competition for FD escalates further. That said, banks are still short-term net beneficiaries given loan-deposit repricing time differences,” HLIB Research explained.

All in, it remained positive on the sector and opined that the risk-reward profile is skewed to the upside; the combination of robust profit growth and undemanding valuations will be impetus driving performance.

 

 

Consumers: OPR increase to stabilise consumer spending, inflation

IN its statement, BNM said the MPC has decided to further adjust the degree of monetary accommodation to “pre-emptively manage the risk of excessive demand on price pressures consistent with the recalibration of monetary policy settings that balances the risks to domestic inflation and sustainable growth”.

For consumers, the OPR hike is meant to control spending and to balance the economy against the current uncertain macro headwinds.

“We cut the OPR from 3.00 per cent to the lowest level in history, at 1.75 per cent, during the Covid-19 crisis in 2020. The lower interest rates made loans cheaper to spur spending. We did this to cushion the impact of the pandemic when the economy was not healthy and in recession.

“It is important to have the right policy at the right time. If we keep the OPR too low for too long when the economy is steadily recovering for example, it could cause too much spending and borrowing, which pushes prices up.

“Higher interest rates help to break this cycle. If we wait until high inflation becomes out of control before we act, it would lead to worse outcomes. By then, we would need to increase the OPR faster and by much more.

“This would harm households and businesses more, especially when it goes hand in hand with high inflation that would hurt everyone’s purchasing power and plunge the economy into a recession. So, it is important for monetary policy to act early to prevent this from happening in the future,” it explained in its frequently asked question (FAQ) segment published with its MPC announcement.

However, now that the economy has been viewed as improving, BNM has decided that this is the right time to introduce more accommodative monetary measures.

“Higher interest rates are intended to encourage people to borrow less and save more.

“When the OPR increases, banks pay higher interest rates on the funds that savers deposit in banks. Savers will benefit from the higher returns on savings. Similarly, banks will also charge higher interest to borrowers to reflect the higher cost of funds.

“Aside from loans, higher interest rates also affect your savings.

“If you deposit your money in a bank account that pays interest, you will get higher returns on your savings too. For example, for the OPR increases in May and July 2022, fixed deposit rates went up by 50 basis points in most banks. Higher returns will benefit savers of all ages, young and old. These include retired persons and other individuals who rely on interest income to cover their day-to-day living expenses.

 

US’ year-end fight against inflation with another rate hike

 

HOURS before the announcement of the rate hike here, US Fed announced another large 75bps hike, pushing its fed funds rate higher to 3.75 to four per cent.

This marks the fourth back-to-back 75bps increase since June 2022, as widely anticipated by market consensus as inflation remained elevated and above the Fed’s two per cent longer-term target on the back of still strong labour market.

The FOMC also reiterated its commitment towards the balance sheet reduction plan as issued in May 2022. As of last week, the Fed’s balance sheet dropped to US$8.72 trillion, cumulative reduction of US$242.4 billion from the highest level in mid-April 2022.

subtitle: How US’ rate increase will affect global markets

Rhe large rate hikes by the US Federal Reserve to contain US inflation have led to higher returns, and higher demand for US dollar assets among investors globally.

It has also influenced the strength of the US dollar against currencies such as the ringgit.

In fixed income, according to RHB Investment, it’s not clear that UST10YR yields have peaked and we need to await to see if the critical resistance level of 4.27 per cent is broken on a sustained basis.

“This implies that extending duration in local currency government bond markets in the US and Southeast Asia is a position that can wait to be implemented, at least in terms of significant allocation of funds.

“The timing could be more appropriate in one to three months. It’s too early to receive at the front end of the US curve. The most appropriate way to play the US curve is 2s/10s curve inversion, where we expect a range of -50 to -70 bps (a view we have had for some time). High quality credit in the US is another asset class we advocate since we believe the US economy is unlikely to head into a deep and prolonged recession in 2023,” it said.

In foreign exchange, RHB Investment continue to believe the DXY index will trade in the 110 to 115 range in 4Q22, followed by 112 to117.

“US dollar-Asia will continue to head higher into 1H23, with the balance of risks tilted towards US dollar-ringgit hitting 4.80-5.00 versus our base case assessment of 4.70 to 4.80,” it projected.

In equities, RHB Investment anticipated a “Santa Claus” rally in the US in December and into early 2023. This rally has materialised earlier than anticipated in 4Q22.

“Hence, we prefer to be cautious at this point on Global equities, with some weakness likely in November as the market digests what the peak FFR could be and how long will it remain elevated,” it said.

Meanwhile, the research team at Kenanga Investment Bank Bhd (Kenanga Research) pointed out that BNM’s fourth consecutive 25 basis points overnight policy rate hike failed to boost the ringgit to appreciate against the strengthening US dollar, mainly due to Fed’s Powell hawkish statement (market estimate for the terminal rate up to 5.25 per cent) and Bank of England’s dovish messages.

“The local note was also dragged down by the weakening of the yuan past the 7.30 per dollar threshold due to weak China’s PMI reading.

“The direction of the ringgit for next week would be mainly influenced by the October’s US inflation readings and the outcome of the US midterm election on November 8.

“The ringgit’s sell-off is likely to persist if there is an upside surprise in the CPI figures and if the market price in a lower terminal rate for Fed funds post-election (if Democrats lose congress).

“Nevertheless, the ringgit is expected to benefit from a potential improvement in the Malaysia 3Q22 GDP growth and hover around the 4.73 to 4.76 against the US dollar,” it noted.

“For savings, deposit rates also depend on factors such as competition among banks for funding, alternative sources of lower-cost funding available to banks, and other business considerations including lending strategies.

“These factors could see interest rates on savings changing more or less than changes in the OPR. Returns on deposits placed with banks also depend on the type of deposits, such as whether you are placing your money in a current and savings deposit account, or a fixed deposit account,” it explained.

“Returns on current and savings deposit account are usually much lower and less sensitive to movements in the OPR. This is because the main purpose of these accounts is to allow you to make transactions and the money in these accounts can be withdrawn at any time.

“In contrast, you will obtain a higher rate of return if you place your money in a fixed deposit account, where you have to commit to place the money for a pre-agreed period. Generally, the longer the pre-agreed period, the higher the interest rates you would receive on your savings,” it added.

Overall, analysts note that BNM continues to expect headline inflation to peak in 3Q22 before moderating thereafter, however noting it will remain high.

Core inflation is projected to average closer to the higher end of their two to three per cent forecast range in 2022.

“Moving into 2023, BNM expects headline and core inflation to remain elevated amid both demand and cost pressures, and any adjustments to domestic policies.

“While government was silent on fuel subsidy rationalisation plan in the Budget 2023 speech, we reckon this measure may be implemented post GE15 sometime in 2023 as government projects CPI to range 2.8 to 3.3 per cent in 2023. Our CPI forecast of 2.9 per cent y-o-y assumes RON95 petrol price ceiling increase to RM2.15 per litre (current: RM2.05 per litre),” HLIB Research said.

Kenanga Research also noted that BNM reckoned that the balance of risk to inflation in 2023 is tilted to the upside and continues to be subject to domestic policy measures on subsidies, as well as global commodity price developments, arising mainly from the ongoing military conflict in Ukraine and prolonged supply-related disruptions.