monetary policy – Page 7 – the _

An article in the Business Times today states that inflationary pressure has subsided:

INFLATIONARY pressures in Malaysia, which have abated since oil prices settled, are expected to subside further this year, say economists.

The economy is unlikely to experience strong cost-push inflationary pressures like that felt by consumers last year when pump prices were hiked following a spike in global crude oil prices, they said. [Rupa Damodaran. Inflationary pressures in Malaysia seen weakening further. Business Times. May 14 2007]

This might signal a possibility of a rate cut some time soon. In fact, there are at least four factors that might make interest rate cut favorable.

One is low inflation as mentioned in the article. Having an inflation-fighting policy when inflation is weak is kind of harsh.

Two, real interest rate is nominal rate minus inflation. Falling inflation, given constant nominal rate causes real rate to go up. Higher returns, in turn, encourages saving, discourages spending or investment, ceteris paribus:

”If real returns continue to swell, we fear it would have some dampening effect on private consumption spending, a trend that may go against the move to spur private consumption,” he added. [Rupa Damodaran. Inflationary pressures in Malaysia seen weakening further. Business Times. May 14 2007]

Further, higher real returns might have caused greater demand for Malaysian bonds:

There was a strong buying interest in the local government bond market last week, especially from offshore parties, which caused yields to fall quite significantly.

[”¦]

Week-on-week, the three-year and five year benchmark MGS fell 24 bps and 25 bps respectively to close at 3.18 per cent and 3.19 per cent.

Meanwhile, the 10-year lost 26 bps to close at 3.47 per cent. [Strong buying interest in govt bonds. Business Times. May 14 2007]

A rate cut would cause real returns to go down and reverse the carrot and stick model, spurring more robust economic activities.

Three, the ringgit is at a nine-year high.

KUALA LUMPUR, May 14 (Bernama) — The ringgit closed higher against the US dollar Monday to hit a new nine-year high since 1998, supported by continued inflow of funds and strong trade surplus, dealers said. [Ringgit Ends Firmer Against US Dollar. Bernama. May 14 2007]

Appreciating ringgit hurts Malaysian export. Strong ringgit makes Malaysian goods more expensive to buyers that uses other currencies.

Four, an expected economic slowdown later this year. Anticipating a slowdown, a rate cut could spur investment and thus possibly stopping an expected slowdown dead on its track.

For recording purpose, below is a table reproduced from Business Times:

The Malaysian equivalent of the Federal Open Market Committee, the Monetary Policy Committee will meet on this coming May 28.

I, of course, prefer the market to set the rate instead of a central bank.

[1147] Of preparing for rate cuts?

On Thursday, the Federal Open Market Committee kept the federal fund rate unchanged at 5.25%.

Phrase of the week: neutral bias.

NEW YORK (Reuters) – The Fed’s shift toward a more neutral bias on interest rates is likely to deal a blow to the dollar in the longer term, but bears expecting a sharp fall in the currency may have to wait a little longer yet.

The dollar slumped to a two-year low against the euro on Wednesday after the Federal Reserve left interest rates on hold at 5.25 percent but dropped a phrase in its statement pointing to future monetary policy tightening. [Shift in Fed tone signals dollar down but not out. Reuters. March 22 2007.]

The Fed is expected to cut rate later this year; a rate cut signals an economic slowdown.

Given Malaysian dependence on the US market, I am convinced that Malaysia would be affected.

The ancients said, all roads led to Rome. With slowing US economy as well as stronger ringgit which hurt local export, this particular road might lead to Rome indeed. So, I am confident of winning this bet.

Our own Bank Negara left our interest rate as unchanged at 3.50% at the last monetary policy meeting on February 26. If the Bank Negara is worried about slowdown, it should cut down rate. In the news however, the Malaysian central bank seems to be very bullish given current circumstances:

KUALA LUMPUR: Bank Negara is confident Malaysia’s economy will remain resilient and grow at a healthy 6% despite moderate global growth predicted for the first half of the year. [Bank Negara says economy still resilient. The Star. March 21 2007.]

If Bank Negara is as bullish as it says, conventional wisdom would either advice the central bank to either increase the rate up or leave it be, depending on the situation, if inflation is the bank’s main concern.