The OPR dilemma

The Star

4 hours ago

PETALING JAYA: Economists are divided on whether Bank Negara should cut the overnight policy rate (OPR) at its Monetary Policy Committee (MPC) meeting tomorrow.
For the past two years, the central bank has kept the OPR unchanged at 3%, following a 25-basis-point (bp) hike on May 3, 2023.
That adjustment was aimed at normalising monetary policy after the pandemic-induced low-rate environment.
Since then, Bank Negara has described its monetary stance as 'slightly accommodative,' maintaining a balance between supporting economic growth and managing inflation.
However, the second half of financial year 2025 (2H25) is expected to bring new challenges, including fiscal reforms such as the rationalisation of RON95 fuel subsidies, an expanded sales and service tax (SST) and rising external trade uncertainty.
Among those advocating for a rate cut is Bank Muamalat Malaysia Bhd chief economist Mohd Afzanizam Abdul Rashid, who argues that a 25-bp reduction would help ease rising pressure on borrowers and sustain private consumption.
He pointed to the widening real interest rate, which rose to 1.8% in May from 1.6% a month earlier, indicating that inflation-adjusted borrowing costs are becoming increasingly expensive.
'This means that, in real terms, borrowers are paying higher interest to service their debts. If this situation persists, it might weigh on aggregate demand,' the economist told StarBiz.
Mohd Afzanizam noted that while headline inflation could edge higher in the coming months – driven by the gradual removal of fuel subsidies and the increase in service tax from 6% to 8% – these changes are administrative, rather than demand-driven.
'This is not demand-driven inflation. It's a one-off adjustment, and in such a case, monetary policy should prioritise growth over price controls,' he said.
Socio-Economic Research Centre executive director Lee Heng Guie is also betting on an OPR cut, citing trade tariffs uncertainties that may cloud exports and spill over into domestic demand.
He cautioned that both business and consumer sentiments have shown signs of weakening, although the services sector remains relatively sturdy.
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Still, Lee described recent economic indicators as a 'mixed bag'.
'Exports declined by 1.1% in May, growth in the manufacturing sector grew by 5.6% in April and manufacturing sales up 4.8% in April. The labour market remains solid, with the unemployment rate remaining low at 3% in April.
'Inflation remains moderate amid concerns about inflation risk due to the expanded SST and rising electricity tariffs in 2H24,' he said, adding that RON95 subsidy rationalisation remains a key 'wild card' for inflation.
A Bloomberg poll of 23 economists showed that roughly half, or 12 of them, projecting a lower OPR.
However, there are concerns that a rate cut could dampen the ringgit's recent gains against the US dollar by narrowing the yield spread with the US federal funds rate.
Mohd Afzanizam downplayed such concerns, noting that the ringgit has appreciated 5.3% against the greenback year-to-date.
He views the ringgit's strength as part of a broader shift in global currency dynamics.
'The current dynamics in the foreign-exchange markets are evolving,' he said, pointing to growing doubts about the long-term strength of the US dollar.
'The US fiscal and trade policies are affecting its growth outlook, which supports the de-dollarisation trend. On that note, we are probably going to see the ringgit appreciate against the US dollar on a sustainable basis,' he added.
Maybank Investment Bank Research (Maybank IB) analyst Winson Phoon also supports a preemptive 25-bp rate cut.
In a recent note, he argued that while current economic data may not yet warrant a cut outright, early action is prudent given weakening growth momentum and rising external risks.
'From a risk management perspective, we believe the risk of cutting too late clearly exceeds that of cutting too early,' he stated.
Phoon also highlighted that Bank Negara's MPC statement in May had already struck a dovish tone, opening the door for monetary easing.
He noted that the bond market – particularly Malaysian Government Securities – has largely price in a 25-bp rate cut.
As such, market reaction following the MPC meeting will depend more on the central bank's forward guidance, whether it signals further easing or a pause.
He added that if Bank Negara opts to keep rates unchanged, it could lead to a slight increase in bond yields.
Taking the opposite stance, economist Geoffrey Williams sees no urgency for Bank Negara to act.
He believes the central bank should hold rates steady, arguing that inflation remains under control and growth is still within a healthy range.
'Inflation is low and was very low in the latest data. While it may rise slightly due to fiscal reforms, it will remain around or below 2% for the year,' he said.
Williams expects any inflationary pressures, including from the expanded SST and RON95 fuel subsidy rationalisation, to be short-lived, adding that stable interest rates would help prevent inflation momentum during these policy changes.
The economist forecasts gross domestic product growth to come in at or slightly above 4% in 2025, and views the domestic financial system as stable and resilient.
'So there's no real reason to change interest rates. The current policy remains accommodative, and that should be sufficient to support growth,' he said.
Williams also voiced concerns that a rate cut could lead to excessive borrowing, particularly when household debt levels in Malaysia are already among the highest in South-East Asia.
'Borrowing is already high at a 3% OPR. Lowering rates could push it higher, which isn't desirable if rates need to rise later.
'Borrowers could find themselves trapped in loans they took at low rates. Meanwhile, savers would also suffer, as fixed deposit returns are already barely keeping up with inflation,' he said.
As for the ringgit, Williams believes the currency's gain is driven largely by global capital flows and trade sentiment, not by domestic monetary policy.
'The rate isn't the main driver of the ringgit right now. It's more about the international capital movements and trade policy expectations,' he added.