This article first appeared in Wealth, The Edge Malaysia Weekly on May 30, 2022 - June 5, 2022

Bank Negara Malaysia has joined the ranks of countries that have raised interest rates in the fight against inflation. In a somewhat surprise move, the central bank has increased its overnight policy rate (OPR) to 2% from a record low of 1.75%, where it had been since July 2020. A Bloomberg survey found that 19 out of 24 economists had forecast an unchanged OPR of 1.75%. 

In its monetary policy statement, Bank Negara cited the sustained improvements in domestic demand on the back of sustained export growth and lower unemployment rate amid improvements in the labour participation rate as factors behind the policy action. The country’s transition to Covid-19 endemicity, along with the reopening of borders and relaxation of movement restrictions, will also help drive economic activity. 

Key risks to growth cited include the further escalation of geopolitical conflicts, supply chain disruptions, adverse change in the development of Covid-19 and weaker-than-expected global growth. 

Looking at central banks around the world, it all started with the US Federal Reserve raising the Fed funds rate by 0.5% this month. It has guided for similar hikes to take place in June and July, followed by three more 0.25% hikes before the end of 2022. 

This will take the Fed funds rate to 2.5% before the new year. This guidance has turned more aggressive, accelerating the rate of increase to address the price pressures seen in the US. Inflation in the US was recently 8.3% year on year, a record high. In turn, bond yields have climbed along with a strengthening US dollar to reflect the Fed’s guidance. 

The European Central Bank too has turned less accommodative, signalling that it will start tapering its quantitative easing programme in the summer and start hiking interest rates in July. The Bank of England has stated its intention to raise its bank rate to at least 1.5%. 

Other central banks in Asia-Pacific such as the Reserve Bank of Australia and the Reserve Bank of New Zealand have done similar things to tighten monetary conditions, citing the need to control inflationary pressures that were already high due to supply chain disruptions and later made worse by the Russia-Ukraine crisis. 

In Malaysia, headline inflation is projected to average between 2.2% and 3.2% in 2022, with core inflation likely to average between 2% and 3%. The less aggressive price pressure is the result of existing price controls put in place and spare capacity in the domestic economy. 

While Malaysia’s inflation outlook remains well within normal range, the need for low, business-supportive interest rates is no longer apparent. Back in 2020, when on account of the pandemic, Bank Negara reduced the OPR a record 1.25% (to 1.75% from 3%) over a short span, it was to ensure ample monetary support during such unprecedented conditions. However, the domestic economy has recovered and is on firmer ground. The central bank has thus guided for a measured and gradual increase of the OPR while remaining accommodative to sustain a healthy economy.

Such a global environment of elevated inflation, accelerating interest rates, rising government bond yields and a strong US dollar presents a sober outlook for the global economy. Indeed, growth prospects have dimmed somewhat for 2023 to reflect not only the above factors but also the disruption caused by the Covid-19 lockdowns in China. Even as the Chinese government has refocused its attention on its previous pro-growth strategy, the dynamic zero-Covid policy lockdowns are likely to have an impact on economic growth in the immediate aftermath.

While growth prospects have dimmed and the risk of a recession has risen, the benefits of economic reopening, the reopening of borders and a strong labour market will still be tailwinds to sustain global growth. Hence, a recession is not on the cards yet. Nonetheless, headwinds have increased and the sky has darkened because of the widespread fallout from the Russia-Ukraine crisis and its knock-on effects. 

In such a volatile market environment, there remain opportunities for investors with a healthy risk appetite, long-term view and a diversified portfolio. Concentrated bets are unwise and having ample cash will be handy for taking advantage of market dips. 

Michael Lai is executive director of wealth advisory (wealth management) at OCBC Bank (M) Bhd

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple's AppStore and Androids' Google Play.