Friday, March 05, 2010

What BNM's normalisation of policy means

Interesting report by Rupa... thanks sis.

WHEN Bank Negara Malaysia said it will move to normalise interest rates, it means the central bank will bring rates to the prevailing economic conditions.

Given the strengthening economy, that could only mean it will raise the key overnight policy rate (OPR) which consequently determines borrowing costs.

But economists say that any move by Bank Negara to normalise interest rates should not mean that business activities would slow.

Although this could mean raising rates from the current two per cent, it does not mean borrowing costs would rise as central bank governor Tan Sri Dr Zeti Akhtar Aziz stressed the policy thrust is still to remain accommodative to support growth.
RHB Research economist Peck Boon Soon explained the need for normalisation which means the process of rolling back of programmes or policies) without affecting economic activities.

"As confidence returns and the economy turns around to record positive growth, you need to roll back what you have implemented earlier gradually to prevent the extremely loose policy from creating unnecessary inflationary pressure," he said.

The extremely low interest rates imply low returns may lead to speculative activities and build up asset bubble or so- called financial imbalances, he added.

He said during the previous crisis, the three-month interbank rate, which was the benchmark guide for interest rates, dropped to low levels.

In 2009, the 3-month interbank rate was at 2.12 per cent (3.48 per cent in 2008) when the economy contracted by 1.7 per cent. This showed that Malaysia's interest rates have been cut to an extremely low level.

"So when you bring back your interest rates to a more neutral level (which will likely be around 3.0 per cent to 3.5 per cent for the 3-month interbank rate), it is considered as normalisation and not tightening per se, as it would not have significant impact on consumer spending and business activities," he said.

He pointed out that normalisation of policy has already started in the US as well when it gradually scaled back its emergency lending programmes to help various financial markets.

It was announced in the US that quantitative easing would stop by end-March and it raised the discount rate by 25 basis points recently to discourage banks from borrowing emergency funds from the Federal Reserve given that the financial markets have improved.

Another analyst explained that in the case of the benign inflation situation in Malaysia, rate hikes will not be looked upon as a tightening measure but an upward adjustment to address the financial imbalances.

"The imbalances refer to higher household leverage (excessively low rates encourage people to borrow more than they should to finance purchases), and to prevent such condition from escalating to undesirable levels," she said.

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