Malaysia inflation to reach 3% by mid-year

Workers are likely to demand for higher wages then.

DBS Group Research noted:

Bank Negara will be having its policy meeting today. No surprise is expected in this aspect as the market unanimously expects the central bank to hold the Overnight Policy Rate (OPR) steady at 3.00% in the coming meeting.

Essentially, healthy GDP growth and low inflation make for a stable monetary policy. Economic growth has stayed above the 5% mark for five consecutive quarters while inflation in 2012 is the lowest amongst the key East Asia economies. On the economic report card, Malaysia has out-performed many regional peers on these two measures.

We expect GDP growth to remain steady at 5.0% in 2013 but inflation will be higher at 2.8%, from 1.7% last year. Strong demand-pull inflationary pressure is expected to build up in the coming months due to the buoyant domestic growth.

As it is, Malaysia output gap is already positive and rising. In addition, Malaysia’s current subsidy programme may prove unsustainable. A cut back is possible after the impending election to ensure longer term fiscal sustainability. This will surely lead to higher prices.

Rapid increase in property prices are also feeding into the price pressure. Last but not least, Malaysia has recently introduced the minimum wage. Companies will surely pass on this higher wage cost to consumers.

These factors will drive inflation higher to about the 3% by the middle of the year. And when inflation starts to creep up, inflation expectation will surely rise. Workers may demand for higher wages to compensate for their loss in real income. This will create a feedback loop on inflation.

With that, there may be a need to anchor inflation expectation pre-emptively. That will surely raise the risk of possible rate hikes towards the second half of the year.