Economic Update - Inflation continues to ease in June

- Malaysia’s inflation rate eased further, falling to 1.6% YoY in June (May: 1.7% YoY), the lowest since March 2010. This reinforces our belief that inflation levels will likely remain subdued for this year despite strong levels of domestic demand, potentially coming in lower than the central bank’s expectations of 2.5%-3.0%.

- The slower rate of price increase was lower than both our house estimate and market’s expectations of 1.7% YoY (Bloomberg Poll).

- The largest factor that contributed to the slower rise in inflation was the declining growth seen in the Food & Non- Alcoholic Beverages index,  as the group with the largest weightage in the inflation index recorded a price increase of 2.9% YoY, slightly lower than May’s 4-month high of 3.0%.

- The MoM price growth also paints a similar story, as the food inflation index expanded by 0.6% (May: +0.7% MoM).

- Prices in the Non-Food items also rose at a slower rate of 1.0% YoY (May: +1.3%), the lowest YoY growth seen since December 2009. Among the factors for the slower rise in this sector was the easing seen in the transport category as price growth slowed to 0.2% YoY (May: +0.4%), potentially signaling the ebbing effect of the impact of cuts in petrol subsidy at the beginning last year.

- Meanwhile, the rise in the Housing, Water, Electricity, Gas & Other Fuels subsector also remained subdued at +1.5% YoY in June, compared with a growth of 1.6% YoY recorded in the previous month.

- For the first six months of 2012, inflation averaged at 2.0% YoY, well below the central bank’s expectations of 2.5%-3.0%. On a MoM basis, inflation slowed to 0.1% MoM, compared with a 0.2% increase recorded in May.

- In the recent monetary policy statement, the central bank noted that price levels will likely moderate for the remainder of 2012. Given that the economy is currently growing below its potential output, BNM also noted that robust domestic demand will unlikely have a major impact on price levels.

- Although strong levels of domestic demand could potentially lead to an increase in prices in 2H12, we envisage inflation to likely slow to between 2% and 2.5% for 2012 – corresponding to the higher base effect as well as falling growth (2011: 3.2% YoY).

- In terms of monetary policy, we believe at the current level of 3%, the OPR continues to be at an accommodative level towards promoting growth, while ensuring adequate levels of price stability. As such, in the current environment, we do not expect to see any rate cut in the quarters ahead.

- However, in the event of severe financial market disruptions, there is ample room for BNM to introduce rate cuts, given a cushioning total of 140bps of positive real interest rates still available.

- With regard to GDP, while we have recently trimmed our 5% growth figure to 4.5%, the amount of policy space available, coupled with the continued expansion in domestic demand, ensures that a strong economic growth in Malaysia remains to be on the cards.

Source: AmeSecurities