Monday, May 24, 2010

April 2010 CPI: Tightening The Screws

April’s consumer price report shows the overall price level has been flat for the fourth month running, while the core price level (ex-food, ex-transport) is barely budging (log annual and monthly changes; 2000=100):


On the surface, that’s not a particularly good sign – if in fact the economy was growing, you would expect prices to be rising as the economy returns closer to full capacity. There’s a couple of reasons why there hasn’t been much movement, and the big one is the appreciation of the MYR (trade-weighted nominal index; 2000=100):


The MYR is up 7.1% in log terms for the year measured by the trade-weighted index, and is up against the currencies of every one of Malaysia’s major trade partners (my definition: >1% share in exports or imports). The big shifts are against the Euro (19.8%) and the GBP (15.1%), but we’re also up against Japan (8.3%), Australia (7.7%) and China (5.4%). Against our regional peers, the MYR hasn’t moved as much, which explains why food prices especially have held steady, as opposed to actually falling.

The other rather (marginally) less important reason is that there actually isn’t much momentum in terms of domestic demand in the economy, notwithstanding the 10.1% GDP growth in 1Q 2010. What we’re seeing over the last few months has really been a trade-driven recovery predicated on a commodity price upswing, which obviously isn’t having much impact on taking up the slack left by the recession much less the existing spare factory capacity which we already had pre-crisis. That in turn means that there’s very little pricing power that can be leveraged to improve business margins, hence the subdued inflation outlook this year.

The problem for the Malaysian consumer going forward is that I think the MYR uptrend has run its course for now – the MYR has risen nearly 8% in log terms in the space of 9 months, which is pretty abnormal even for a highly volatile international forex market. If BNM’s normalisation of interest rates continues pulling in portfolio capital, then I’d start to consider MYR to be overvalued again, much like it was at the end of 2007. The long term structural story for MYR is still intact, but I’m looking for a breather so that the fundamentals can catch up with market prices.

On that basis I’m still looking for higher inflation in the second half and a consolidating exchange rate, but we’re likely to average under 2% CPI growth for the year.

On a side note, subdued inflation and a stronger Ringgit both mean that BNM’s tightening shift is being magnified i.e. monetary policy is tightening faster than implied by the two 25bp hikes already made. My view remains that BNM should’ve let held fast at the last MPC meeting, with the next hike in July. If they do hike one more time in July, I think that will be it for the year.

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