March 2011 Monetary Conditions Update

I’m increasingly leaning towards the view that we might see a rate hike tomorrow, when BNM’s Monetary Policy Committee is scheduled to meet. The reasons aren’t hard to figure out – inflation is rising, and credit creation is probably above BNM’s comfort zone (and mine). I’d also consider that 1Q 2011 growth will probably come in stronger than people expect.

But I’m getting ahead of myself. Money supply growth on its own isn’t too excessive (log annual and monthly changes; seasonally adjusted):

Annual M1 growth is on the high side, almost entirely due to strong growth in demand deposits. Otherwise, there’s nothing compelling of note here.

Inflation has gone up, but appears to have stabilised in March – what we’re seeing is really a one-time jump in consumer prices due to higher petrol costs.

On the interest rate front, short term yields (BNM and Treasury bills) have held steady, but prices of longer dated instruments (MGS) have started falling:

Note that the MGS yield is steepening at the short end, but flattening at the long end. There’s two sides to this: first is that most of the government debt issued from the onset of the recessaion onwards has been for 3-5 year maturities. As conditions normalised, the greater supply would tend to increase yields for MGS of that duration – there’s less appetite for the greater supply. Secondly, the same impetus would tend to increase demand for longer dated securities at the expense of shorter maturities. So I think what we’re seeing here is really a shift in market preferences.

Interesting side note: It appears that BNM is also shifting the duration of its liabilities, even if yields on BNM bills haven’t budged much. The data indicates more issuance in 6 month and 12 month BNM bills, and less 3 month BNM bills. Again two factors here: investor comfort with risk, and probably BNM’s desire to lock in lower rates for its open market operations.

If as I suspect we’re on the verge of an upward move in Malaysian interest rates, than it makes sense for BNM to lessen the impact on its P&L especially since they’re facing the prospect of leaching even more liquidity from the interbank market. The interest cost of liquidity operations is already an annualised RM2.8 billion a year – a hefty cost for BNM to bear.

Here’s where it gets interesting: despite the rate hikes last year, average lending rates are not much above last year’s average level, and have been trending down throughout 1Q 2011:

In fact lending margins are not much above historical lows:

So there’s a lot of competition between banks for loans, and it shows (log annual and monthly changes):

Before someone says “excessive household debt!”, loan increases are pretty much across the board (log annual changes):

Lending growth to non-households has exceeded household borrowing for five of the last six months. So its not just households who are adding on debt, though its clear that the loan to value restrictions on housing loans don’t appear to be cooling mortgage demand (log annual and monthly changes):

I’ve thought for some months now that a resumption of BNM’s upward interest rate path would depend more on credit conditions than on inflation. Based on the above, I think there’s a good case to be made for another 25bp increase in the OPR tomorrow (with another 100bp increase in the SRR for good measure).

The only thing that might be holding BNM back is that a rate hike now is ipso facto a commitment to raise interest rates in the future. If as I think growth is stronger than expected, than that’s not necessarily a bad thing.

Technical notes:

All data from the March 2011 Monthly Statistical Bulletin from Bank Negara Malaysia