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Bank Negara’s one-two punch [06-05-2011]  
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Against market expectations, Bank Negara Malaysia (BNM) yesterday raised the overnight policy rate (OPR) by 25 basis points (bps), citing concerns on inflation.

BNM also increased the statutory reserve requirement (SRR) ratio by 100bps to 3%. Though the interest rate hike was widely unexpected, it may be an indication that the economy — as well as inflation — is gathering strength.

“The hike in the OPR is somewhat a surprise. While it would reflect a tightening on BNM’s part, we should not view it negatively as it indicates that BNM feels the economy is doing well, therefore the hike is made possible,” OSK director of research Chris Eng told The Edge Financial Daily yesterday.

Of 16 economists polled in a Bloomberg survey previously, only seven anticipated an increase in the OPR. Nine had expected the OPR to stay unchanged at 2.75%. The increase marks the first change in the OPR in 10 months.

The interest rate benchmark was last revised in July 2010, when it was raised by 25bps to 2.75%. Prior to that, the OPR was tightened twice by a magnitude of 25bps each, from a low of 2% during the recent global financial crisis.

Most economists had expected the first hike to take place later in the year, as the OPR is gradually returned to its pre-crisis level. Meanwhile, the SRR hike is seen as a pre-emptive effort to curtail the build-up of excess liquidity, which BNM said could result in financial imbalances and create risks to financial stability.

The SRR, BNM said, is an instrument to manage liquidity and does not signal the central bank’s position on monetary policy. This is the second increase in the SRR in just over a month. The central bank had just raised the SRR by 100bps, from 1% to 2%, from April 1, 2011.

The increase in the OPR will result in an increase in the country’s BLR (base lending rate) as it is conventional for banks to adjust the benchmark lending rate accordingly.

“This will result in higher BLR. The banks usually will adjust their BLR immediately, while deposit rates will lag, depending on maturity. As a result, the banks tend to gain when interest rates are raised,” an economist said.

However, an analyst also noted that the two recent increases in the SRR may affect banks’ margins, as they may not be able to fully pass them down through a higher BLR. “The reversal of CIMB Bank’s decision [end March] to increase its BLR after the last SRR hike, as well as comments from BNM suggest that only the OPR should be used to dictate the BLR,” he added.

Nonetheless, the analyst also noted that any margin squeeze for banks could be alleviated by not raising deposit rates as much as the quantum of the hike in lending rates.

The SRR is the amount of funds that banks have to keep with BNM interest-free, for the central bank to manage liquidity. It is calculated as a percentage of a bank’s eligible liabilities.

Domestic spending and the property market could be hit by the higher BLR, as spending moderates in anticipation of more increases. “The increase in BLR will likely hurt lending as consumers and businesses turned cautious in anticipation of further hikes. This will result in some impact on consumer spending and business activities,” said the economist.

However, he added that the overall impact on the economy may be minimal given that further increases are likely to be gradual, and interest rates are still low. CIMB Research recently reported that loan applications for residential property showed a strong rebound in March with a 74.1% increase from the previous month.

While the property market remains buoyant, the quantum of the increase was a surprise to industry observers, especially given that it had fallen for four consecutive months before March.

In a report issued on Tuesday, CIMB Research noted that the rebound could have been driven by borrowers who rushed to lock in low interest rates, in anticipation of higher borrowing costs in the near-term. Additionally, the research house noted that investors continue to view property investment as a defensive hedge against rising inflation.

Moving ahead of the curve
Analysts noted that BNM has been ahead of the curve as far as interest rates are concerned in the past few years. Just before the 2008/09 global financial crisis hit, central banks around the region were raising interest rates as commodity prices and inflation soared.

However, BNM kept the OPR at 3.5%, a level that had remained unchanged since April 2006. When the global financial crisis struck, the OPR underwent three consecutive cuts from November 2008 to February 2009, and was trimmed by a total of 150bps to 2%.

After the end of the crisis and as growth started to pick up, BNM was among the first central banks in the region to increase interest rates in March last year. It is now taking a more hawkish stance again, and appears to be looking to “normalise” rates as growth and inflation gain momentum.

An analyst expects the process of “normalisation” of interest rates to ultimately bring the OPR back to around the 3.5% level, barring external shocks. The next monetary policy committee meeting, the fourth for the year, will take place in two months on July 8.

“In the region, despite some moderation, growth has remained strong, supported by robust domestic economic activity. Global inflation has, however, increased on account of rising energy and commodity prices,” said BNM yesterday.

Inflation rose to its highest point in two years, climbing 3% year-on-year in March. For the first three months of the year, inflation rose 2.8%. The latest data on inflation, for the month of April, is due for release on May 31.

“Although the global recovery is expected to continue going forward, downside risks have increased, arising from the potential for higher energy and commodity prices, possible supply disruptions following developments in Japan, and the heightened volatility in capital flows to emerging economies,” said BNM.

Central banks in the region are also grappling with the same concerns. The Reserve Bank of India (RBI) lifted its benchmark rate by 50bps to 7.25% on Tuesday, after the country’s wholesale-price inflation sped to 8.98% in March, exceeding the central bank’s forecast of 8%.

Prior to that, a Bloomberg survey polling 25 economists saw the majority predicting a mere 25bps increase in the country’s repurchase rate.

“Current elevated rates of inflation pose significant risks to future growth. The inflation rate will remain close to the March level over the first half of 2011/12, before declining,” said RBI governor Duvurri Subbarao.

In the Philippines, inflation reached its highest point in two years. The consumer price index climbed 4.5% y-o-y in April, according to the National Statistics Office in Manila.

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