Approaching the end of BNM rate hike cycle this time

Although the 25bps hike in May was a surprise to the economists, both equity and bond markets reacted mildly to the rate hike announcement 


BANK Negara Malaysia (BNM) raised its Overnight Policy Rate (OPR) by 25 basis points (bps) to 3%, marking its first rate hike of the year in 2023. The rate hike on May 3 is in line with our view earlier, where we believe the BNM will have at least one more hike in order to increase the variability of OPR given the global recession risk. 

Surprise Hike in May 

Although the 25bps hike in May was a surprise to the economists as most of the economists were expecting the hike to occur in the second half of 2023 (2H23), both equity and bond markets reacted mildly to the rate hike announcement. 

Among the equity markets, the rate-sensitive sectors financial, technology and property sector faced selling pressure earlier the day before the announcement was made. After 3pm, when the announcement was made, financial and property sectors reacted to the news positively with 0.5% from the intraday trough. Meanwhile, the technology and property sectors showed relatively muted reaction with only 0.2% and 0.1% gains from intraday trough. 

The local bourse FTSE Bursa Malaysia KLCI (FBM KLCI) closed the day marginally green with 0.37% gain after the announcement (3pm), with the heavyweight banking sector leading the gain. Meanwhile, the bond market showed muted reaction as three-year Malaysian Government Securities (MGS) yield up by 1bps to 3.32%, while 10-year MGS yield declined -4bps to 3.7%. On the currency front, US dollar (US$) has depreciated by -0.2% against ringgit from 4.464 on May 2, 2023 to 4.4552 on May 3, 2023. 

MPC Cites Positive Growth in Domestic Economy

The language of Monetary Policy Committee (MPC) statement sounded neutral compared to previous statements in the last two MPC meetings. In the previous statements, it carried a negative tone for global development in order to support the decision of keeping rates unchanged. 

This time, the MPC specifically cited China’s recovery to potentially boost tourism sector, a resilient domestic labour market, as well as continued government expenditures in the form of infrastructure projects. The rejuvenating economy is the main justification for the pullback of loosening monetary policy put in place during Covid-19 era. 

Nevertheless, the MPC also cited the use of price controls and fuel subsidies as factors for the lower inflation figures, indicating that if the government were to pullback some of these fiscal aids, the rather contained inflation level (3.4% YoY in March 2023) that we are seeing currently might not be sustainable. The rate hike decision this time could help to relieve the inflationary pressure further down the road. 

Since the US Federal Reserve (Fed) started its tightening path on March 2022, the divergence between Fed rate compared to OPR has been widening at a rapid pace. The spread has broadened to an alarming level at a historic high of 2.25% on May 2023. 

The synchronised 25bps hikes by Fed and BNM have caused US$ to depreciate -0.41% against ringgit from May 3, 2023. According to Bloomberg consensus, the market is counting on the USD to continue weakening to reach RM4.15: US$1 level by 2024 on the back of the expectation about the Fed has almost reached its terminal rate, and rate cut is likely to occur in July 2023. Meanwhile, the market is expecting OPR will stay at a 2.75%-3% level in 2024, resulting US$ depreciating against ringgit despite both central banks raising interest rates by the same magnitude. 

The real interest-rate deficit has narrowed to -0.4% from the low of -2.45% in August 2022. The real interest deficit will potentially erode the purchasing power by reducing the value of the money on hand, indirectly clouding the economic growth in the long term. 

Fortunately, with the efforts taken from both fiscal and monetary policies and easing supply chain bottlenecks, the inflation rate has been controlled within the range of 3.4%-4% over the past six months while the inflation rate in most developed countries surged to double high single-digit and double-digit level. We hold a constructive view that the headline inflation will maintain at current level over the next couple of months and to gradually decline to the range of 2.5%-3% next year, with the assumption that the removal of government subsidies, if happens, will be on a progressive manner. 

Expect OPR to Maintain at 3% for 2023

Given our analysis earlier, we are of the view that global uncertainties, which would subsequently affect the local growth outlook, will become the one of the considerations for MPC to determine the monetary policy moving onwards. Also, the local economic growth momentum will be closely monitored by MPC in order to control at a manageable level to avoid over-heating inflation. 

Our base case for OPR is to maintain the current level of 3% for the remainder of 2023 to support accommodative growth while also managing the divergence between Fed rate and OPR. However, we acknowledge the possibility of another 25bps rate hikes if the domestic economy appears to be stronger than expected. 

Mid-to-long Duration Bond, Financial Sector is Our Pick

Although theoretically, an increase in the OPR should result in a rise in yield, yet we have observed a trend in recent months where the yield has been gradually decreasing despite multiple OPR hikes. This indicates that the market has already factored in the BNM terminal rate within the 3% range. 

As a result, the current 10-year MGS yield at 3.7%, reaching its historical average level since 2008. In light of this, we suggest that investors who wish to secure the current attractive yield offered by the fixed income assets to consider allocating some of their exposure to mid-to-long duration bonds. 

On the equity side, we maintain our optimistic outlook for the Malaysian banking sector and believe that the recent 25 bps hike to 3% by BNM will help to relieve some pressure on the net interest margins (NIMs) of banks in the second quarter of 2023 (2Q23). Recently, we have noticed a downtrend in banks’ NIM due to the intense deposit competition between banks and continued decline in growth of current and savings account (CASA). We opine that the banks’ NIM will improve moving forward with the assumption that the OPR is likely to stabilise at the current level. 

  • The views expressed are of the research team and do not necessarily reflect the stand of the newspaper’s editorial board. 

  • This article first appeared in The Malaysian Reserve weekly print edition