As can be seen from Chart 1, from the 75 basis points (bps) hike by the Bank of Thailand to the 425 bps hike by the US Federal Reserve (Fed), the year 2022 has certainly been a busy year for central banks.
To fend off inflationary pressure that has been persistent throughout the year, central banks had to hike rates. The Bank of Japan, while not lifting key benchmark rate, allowed its 10-year Japanese government bonds to move 50 bps from its 0% target, instead of 25 bps earlier. It is a move that is seen recognising that inflation is finally biting the Japanese too.
Understanding inflationary pressures and forecasting where it is going is not an easy task. Inflation is a combination of many factors and not just commodity prices and supply chain disruption. Although the global economic momentum has eased, global aggregate demand is still rising and is much higher than it was before the pandemic.
In theory, inflation is tamed by using monetary tightening measures. Essentially, raising interest rates. This impacts consumers and businesses with higher borrowing costs, resulting in lower consumption as well as a slower pace of investments, which in turn will reduce aggregate demand. Nevertheless, rate hikes have also other consequential impacts on the economy in the form of a weaker or a stronger currency.
For example, for the United States, the relentless increase by the Fed has caused a significant rally in the US Dollar Index, which rose to a high of US$114 (RM501) last year, up almost 20%, before easing to close the year at US$103 (RM454), down 9.3% from its peak, but still higher by more than 8%. The surge in the dollar made US imports cheaper from the rest of the world, in particular those from China, even cheaper, which allows the US retail prices at the store to be relatively lower than they used to be before the rally in the dollar.
In essence, while the surge in US interest rates has reduced disposable income due to higher borrowing costs, which in turn lowered consumer demand, it has also caused imported end product prices to be relatively cheaper than before, allowing aggregate prices to be lower as well.
Compared to many central banks in the region or globally, Bank Negara moved to raise the benchmark Overnight Policy Rate (OPR) by 100 bps in 2022. This is a rather muted reaction.
Based on the year-to-date core CPI of 2.9% up to November 2022, the inflationary pressure experienced by Malaysia is not within Bank Negara’s forecast of between 2% to 3% for the year and going into 2023. Core inflation will remain elevated at the beginning of the year but may ease later on.
Bank Negara may leave the OPR unchanged for 2023 at 2.75%. After all, a higher rate of between 25 bps to 50 bps as predicted by many will only result in higher borrowing costs for consumers and businesses, which may accelerate the pace of economic slowdown in 2023. By leaving the OPR unchanged, Bank Negara is signalling that it is done with raising rates.
One of the arguments for higher interest rates is whether depositors are getting positive real returns, which is the difference between fixed deposit rates and inflation. Chart 2 shows that based on November 2022 statistics, the depositors are at the losing end as the 12-month deposit rate was 132 bps lower than the monthly inflation print of 4%.
Many have priced in the scenario that the central bank will raise rates by 50 bps to take the benchmark OPR to 3.25%, the level last seen in March 2019, almost four years ago. That’s before Covid!
The upshot of all this is what is fair to depositors and what is acceptable to borrowers. Without borrowers/consumers economic activity is dampened and hence growth. Without depositors, banks may become illiquid. From a consumer’s point of view, interest on deposits should exceed core inflation of say about 3%. From a borrower’s point of view, the market lending rate for an SME should not exceed 6% p.a. Otherwise, growth is hampered. Here lies the dilemma for BNM.
Reference:
How high is high? Pankaj C Kumar, The Star, 7 Jan 2023
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