After pausing rate increases in June, policymakers raised borrowing costs again at their policy meeting on July 26, the 11th time since March 2022, in an effort to curb inflation. The quarter percentage-point hike, an unanimous decision, pushed the target range for the Fed's benchmark federal funds rate to 5.25% to 5.5%, reaching the highest level in 22 years. This marks the most aggressive tightening period in recent years to combat inflation. The Fed has been progressively increasing the rate from 0.25% to 5.5% since March 2022. The possibility of further rate increases will depend on data, and the Fed will consider the extent of additional policy firming.
In contrast, Malaysia's central bank will maintain its key interest rate unchanged at 3.00% in July 2023, which was its pre-COVID pandemic level, and it will keep it steady for the rest of the year, as signs of cooling inflation have been observed.
With the U.S. Federal Reserve, the European Central Bank, and the Bank of England still determined to raise rates to control inflation, the ringgit has experienced a nearly 6% decline against the dollar this year, losing more value compared to its Southeast Asian peers.
Impacts on Malaysia's economy
Given the scenario where the US Federal Reserve continues to increase interest rates while Malaysia's central bank has paused its rate hikes, it is likely that the Malaysian currency (ringgit) may continue to depreciate against the US dollar. When a country's central bank raises interest rates, it typically attracts more foreign investment, which strengthens its currency. Conversely, when a central bank keeps rates unchanged, especially in the face of other major central banks raising rates, it may result in a weaker currency.
With the Federal Reserve's decision to raise interest rates aggressively to combat inflation, there are several implications and potential impacts on Malaysia's economy:
Capital Outflows: As the US interest rates rise, investors may find US assets more attractive, leading to capital outflows from emerging markets like Malaysia. This can put downward pressure on the ringgit.
Inflation and Imports: A weaker ringgit may increase the cost of imports for Malaysia, leading to higher inflationary pressures in the economy. Malaysia relies on imports for various goods and services, and a weaker currency can contribute to rising import costs.
Trade Balance: A weaker ringgit can make Malaysian exports more competitive in international markets, potentially boosting export revenues. However, the impact on the trade balance will depend on several factors, including global demand and the responsiveness of exports to changes in currency value.
Debt Burden: If Malaysia has foreign-denominated debt, a weaker ringgit could increase the cost of servicing that debt, potentially creating financial challenges for borrowers.
Foreign Investment: A depreciating currency may make investing in Malaysia less attractive to foreign investors, potentially impacting foreign direct investment (FDI) flows into the country.
Inflationary Expectations: The Federal Reserve's aggressive stance to combat inflation in the US might influence inflationary expectations in Malaysia. If people expect higher inflation in the future, it could impact consumer spending and investment decisions.
Overall, Malaysia's central bank will need to carefully monitor the situation and consider its own economic conditions when making decisions about interest rates. A weaker currency can have both positive and negative effects on the economy, and policymakers will need to strike a balance between managing inflation, supporting economic growth, and maintaining stability in the financial markets.
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