Will key interest rate continue to rise?

The first interest rate hike for quite a while announced by Bank Negara Malaysia last week did not dent sentiment both on stocks and as several analysts said, spending in general.

It was expected as given the raise in the overnight policy rate (OPR) was just 0.25 per cent, and from a historic low of 2 per cent, the hike was insignificant. But whether Bank Negara will stop at that is another question altogether.

Banking stocks, as anticipated, responded well as the increase means better interest margins for banks but they were quick to assure customers that the OPR remained low compared with the historic lows in early 2009 when keeping interest rates low was made one of the strategies to face the-then severe economic downturn.

But the last three months have seen the global economy returning to recovery mode and in Malaysia's case, a growth of 4.5 per cent was recorded.

Spending by households and businesses are expected to continue expanding with the support of a stable labour market and confidence among customers and businesses.

The question now is whether Bank Negara will continue to raise the OPR rate.

The market believes so, at least between 25 and 75 basis points, but on a gradual basis till the end of 2010. There will be four more policy meetings this year.

The market is split on the monetary policy outlook. While the majority felt that the central bank would be prompted to go ahead with more increases now that the Malaysian economy has come back on the growth track to emerge out of the recession, the central bank's conservative stance could mean it may well wait for indications from its counterparts in the US and also the region.

Governor Tan Sri Dr Zeti Akhtar Aziz has repeatedly reminded the media to use the term "normalise" and not "tighten" when describing the central bank's anticipated monetary policy change.

It is left to the market to figure what the "normalised" rate would be like for Malaysia which only introduced the OPR in 2004. At that time, the rate stood at 2.7 per cent.

In OSK Research's banking analyst Keith Wee estimates, even if Bank Negara were to raise the OPR by 75 basis points over the course of the year, the OPR at 2.75 per cent would still be significantly below the 5 per cent to 3.5 per cent range between September 2001 and October 2008.

Being the only second rate hike cycle over the past decade since the 1998 financial crisis and given that interest rates are being raised from historical lows, gradually normalising interest rates is unlikely to negatively affect loan growth and asset quality.

During the last OPR hikes (November 2005-March 2006) totalling 80 basis points, Wee said the BLR rose by a much larger 74 basis points versus one-month fixed deposit rates, 3-month fixed deposit rates and 6-month fixed deposit rates, leading to strong net interest margins but the current system flush with liquidity will ensure that deposit rates are likely to remain sticky.