Can interest rate hike help fight inflation?

Talk is rife that banks are preparing to raise interest rates and are just waiting for the cue from Bank Negara.

Many analysts and economists are, however, divided whether Bank Negara will raise the overnight policy rate (OPR) at its next monetary policy meeting on July 25.

“If there is any hike, it may not be in the third quarter,'' opined an economist.

“Even in the US, there is negative interest rate. People still live with it because of the poor growth scenario."

Another industry player observed: “Based on the monetary policy perspective, a rate rise is imminent. “But we may have to take a holistic view of things in view of the current situation."

A senior economist said: “Interest rates have gone up in countries where inflation has remained stubbornly high. In the case of Malaysia, it has been a spike following the drastic rise in petrol price. “We have to weigh the factors carefully," he added.

“The fuel price hike had a certain inflationary effect but the slowdown could be due to external uncertainties. That, in a way, may ease inflationary pressures."

Such comments mirror the debate that might be going on within the corridors of Bank Negara, which until now has staunchly maintained that inflationary pressures seen throughout the world are a result of cost rather than demand.

And in such a situation, raising interest rates might not be the best medicine to prescribe for combating inflation.

Regardless of those earlier views, the situation now may be a little different and that has much to do with inflation rising through the roof in many other developing countries.

And it has also got to do with the response of central banks and regulators in those countries to higher inflation.

The dilemma over interest rates has now spilled over from the rest of the world into Malaysia. Goods are more expensive and the recent hike in petrol prices is expected to push the rate of inflation here to multi-year highs.

And the last thing any central banker would want to do is to let inflationary expectations in any economy fester and snowball into a serious headache if left unchecked.

However, in a time of negative interest rates (inflation being higher than interest rates), there can be only two possibilities - rates being maintained or raised.

Of course, banks make money on higher interest rates but in the long run, they may suffer from potential non-performing loans or worse still, poor demand for loans.

Already, there are analysts who view Malaysia's household debt to be pretty high.

Association of Banks in Malaysia president Datuk Seri Hamidy Hafiz said interest rates were never a function of loans growth, in response to a query on whether banks were hoping for rate hikes that could offset slower loans growth.

In the case of hire purchase loans, there are some upward adjustments because a lot of the rates are below or slightly above the cost of funds, which is around 3.6% or 3.7%.

In an environment of slowing growth, banks will probably have to come up with other ways to protect their bottom line. For example, they will probably look for further efficiencies, guard their asset quality more closely and find other avenues of non-interest income.

Up to May, banks are still experiencing fairly good loans growth and there has been no change in the cost of funds, as reflected in the interbank rates.

Talk of slowdown in loans growth, at the moment, may be based mostly on expectations. - News analysis by Yap Leng Kuen (The Star)

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