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The central bank has to rebuild monetary policy buffer for future shocks. It is confident that a gradual normalisation of interest rate will not hurt economic growth although it recognises that the downside risks to growth will remain.

IN an almost synchronised manner, central banks in the world with the US Federal Reserve (Fed)leading the pack, are rushing to raise their key interest rates in a bid to tame soaring inflation and anchor inflation expectations.

The Russia-Ukraine military conflict-triggered energy and commodity prices surge in recent months had exacerbated the already elevated global inflationary pressures.

The cost and price shocks have collided with the strong recovery in demand for goods and services, upsetting the imbalances between supply and demand and pushing prices to higher levels.

Global inflation is forecast to reach 7.4% in 2022 – the highest level since 2008. This is compared with the average annual global inflation of 3.8% from 2001 to 2019.

Inflation is now running well above central banks’ targets in almost all advanced economies and most emerging markets as well as developing economies. The prices of fuel, electricity, food and raw materials are going up as well as wages and cost of services.

In most countries, cost-push inflation is the main culprit for price increases due to production disruptions, or increases in production costs such as high oil prices and raw material costs as well as wages.In the US economy, as the pressures of the supply and demand side are working together to push inflation up, the Fed is compelled to deliver stronger doses of interest rate and more hikes to bring inflation down.

But the Fed’s fast and over-triggering moves could risk a hard-landing for the US economy.

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Why should Bank Negara normalise interest rate?

Following in the footstep of other central banks, Bank Negara has hiked the overnight policy rate (OPR) by 25 basis points (bps) to 2% in May and another 25 bps to 2.25% this month.

More rate hikes are expected ahead, bringing the policy rate to between 2.5% and 3% from 2022 to 2023 after taking into account the incoming data, implications of evolving external and domestic developments on economic growth prospects as well as inflation trajectory.

What is the rationale behind the move?

Our assessment indicates the following:

> Gradual removal of a high degree of monetary accommodation to build a policy buffer. Amid the presence of heightened external headwinds to global economy and downside risks to domestic economic growth, the continued recovery we are experiencing provides room for Bank Negara to continue removing the extra monetary accommodation delivered during the Covid-19 pandemic.

The central bank has to rebuild monetary policy buffer for future shocks.

It is confident that a gradual normalisation of interest rate will not hurt economic growth although it recognises that the downside risks to growth will remain.