MALAYSIA could see a modest increase in its benchmark interest rate next year as the country’s economic outlook improves.

       The likelihood of the US Federal Reserve (Fed) to begin unwinding its “easy money” policy by the end of this year is also a factor that could drive Malaysia’s key rate higher in 2022.

       “Our interest rates have been kept low for quite some time already in order to support our flailing economy. But with the economy expected to be on a stronger footing next year, we think Bank Negara will begin to look at raising the overnight policy rate (OPR),” one fund manager tells StarBizWeek.

       “In addition, with rising inflation in recent months, real rates have turned negative; therefore, there’s a need to adjust the OPR higher,” he adds.

       The Fed’s decision to tighten its monetary policy, the fund manager argues, could also put pressure on Bank Negara to tighten to manage the risk of capital outflows.

       The Fed indicated last week it would likely start withdrawing some of its easy-money policies by reducing its asset purchases before the end of 2021. But it would likely hold the US benchmark rate until late 2022.

       All-time low

       Bank Negara is widely expected to keep the OPR unchanged when its monetary policy committee (MPC) meet in the week ahead to support the country’s still-languishing economy.

       The central bank has kept the OPR at an all-time low of 1.75% since the last adjustment in July 2020.

       Amid the economic shock caused by the Covid-19 pandemic, the central bank slashed the OPR four times last year for a cumulative 125 basis points (bps), as it expected the huge reduction could help speed up the recovery of the country’s economy.

       The expansionary monetary policy stance was in line with the move of major central banks across the world to cope with the economic fallout caused by the Covid-19 induced lockdown.

       As it stands, most economists expect Bank Negara to continue to maintain the OPR, on which commercial banks based their deposit and lending rates, at the present level in the next, and final, MPC meeting for the year in November to support the economy.

       Gradual adjustment

       In Asia, South Korea is the first major economy to raise interest rates since the coronavirus pandemic began.

       The Bank of Korea last week increased its base rate of interest from a record low of 0.5% to 0.75%. The adjustment came as the South Korean central bank attempts to balance the need to support the country’s economic recovery against the risks of surging household debt and rising inflation.

       Bank Indonesia recently indicated its intention to reducing liquidity in the financial market next year in response to the Fed’s taper plan. The Indonesian central bank said it plans to raise its key seven-day reverse repo rate by the end of 2022, among other measures.

       Bank Islam Malaysia Bhd chief economist Mohd Afzanizam Abdul Rashid notes the Fed is a trend setter for global monetary policy, given the fact that the US dollar is widely used in international trade and capital markets.

       In that sense, he says, Bank Negara may also be monitoring the Fed’s move. While Bank Negara’s policy may not move in lockstep with the Fed, the latter’s move will certainly set the stage for future policy responses.

       He expects inflation to creep up, as the country’s economy begins to recover gradually next year.

       “At that point, Bank Negara will have to weigh the benefits of having OPR at an all-time low and the (economic) costs associated with excessive policy accommodation,” Mohd Afzanizam says.

       “If allowing the interest rate to be at a low level for a protracted period would do more harm than good, Bank Negara may have to begin the rate hike cycle. Another consideration is the financial stability,” he adds.

       He explains that while low OPR helps promote investment and spending, it could also result in excessive risk taking as investors seek higher returns.

       “We opined that such discussion (possible OPR hike) would gain more traction next year,” Mohd Afzanizam says.

       Nevertheless, he says any increase will likely be gradual, and dependent on how soon the country’s economy recovers from the current downturn.

       Increase in May

       According to CGS-CIMB Research, Bank Negara would likely increase the OPR by up to 75 bps to 2.50% by the end of next year, as the country’s economic outlook improves.

       “We expect the OPR to follow the gentle upward drift in short-term interest rates and inflation expectations globally,” the brokerage writes in its recent report.

       “We foresee a total of 75 bps in rate increases by end-2022, with the first hike coming as early as May next year,” it adds.

       Inflation in Malaysia eased to a four-month low of 2.2% in July from 3.4% in June and 4.4% in May.

       Bank Negara last month lowered its gross domestic product (GDP) growth forecast for 2021 to 3%-4%, from its earlier projection of 6%-7.5%, after taking into account the reimposition of nationwide containment measures in June.

       The government is expected to release its GDP growth forecast for 2022 next month when the Budget is unveiled.

       Meanwhile, RAM Ratings expects Malaysia’s GDP to expand between 7% and 8% in 2022 on low-base effects amid the underperformance in 2021.

       Sans base effects, growth should be around 4%-5%, supported by the expected reopening of sectors and gradually diminishing domestic spare capacity, says the credit rating agency.