Interest Rate Hikes: Does it Matter?

There are research houses who maintain that there will be no overnight policy rate (OPR) hike during the Monetary Policy Committee (MPC) final meeting in November, keeping the end-2022 interest rate at 2.50 percent.

For 2023, one brokerage firm has priced in two 25 basis points (bps) rate hikes, bringing the OPR to 3.00 percent. Meanwhile, the energy crisis in Europe will likely push the European Union into recession, and China’s property market woes could only be the beginning of a major problem. 

Although Bank Negara Malaysia raised the OPR by 25 bps to 2.50 percent on 8 September, its third consecutive hike, it has not stemmed currency depreciation and hence food inflation.

The outlook for the US dollar/ringgit is likely to remain bleak. Year end 2022 forecast is 4.61 (USD to ringgit) due to a weaker trade surplus and adverse impact from developments in China. 

Going forward, the level seems to be more adverse (as forecasted by The Economy Forecast Agency):

One may argue that exchange rate depreciation is due to several factors beyond BNM. But have you observed that when there is IMF intervention, interest rates are hiked to stem outflows. That’s a crisis situation and some “hot” money may return. Here we have a chance to contain food import inflation and stabilise currency depreciation in the medium-term. Unless we move away from growth-centric policies, we are in for higher inflation and more depreciation (of currency) in the medium-term.

Malaysia’s growth for Q3 2022 is anticipated to be 8.8%, slightly lower than 8.9% for Q2 2022 (according to CGS-CIMB Research). But it may drop sharply in Q4 2022 with decline in commodity prices and softening prospects in China and the U.S.

What does that mean? It is more fuel for exchange rate depreciation. That is why BNM has to be more hawkish and raise OPR by at least 0.75% in November. It matters if we are to reduce imported inflation, especially on food.

Beyond interest rates, the Government has to look at overseas investments by GLCs and reverse the flow by disposing assets where possible. The return of Malaysian funds overseas will partly help stem depreciation of the ringgit. The other option is to examine the flows – are these pure speculative forces and/or large remittances by locals/foreigners.

Whatever the case, the fight against inflation is multi-pronged and I have only focused on exchange rate depreciation and its impact.

References:

Research houses mixed on expectation of year-end interest rate hike, Malaysiakini/Bernama, 9 September 2022

USD to MYR Forecast, The Economy Forecast Agency