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The key message in Australia's and Malaysia's surprise rate hikes

Just as the market began to debate when the easing cycle in Asia might begin, two central banks in the region surprised the market by hiking rates unexpectedly in May. We believe these decisions contain important insight into how central bankers globally are thinking about monetary policy.

A change in approach to central bank policymaking?

In the most recent edition of Global Macro Outlook , we argued that the market may need to adjust to the idea that central banks could be much more comfortable with the concept of financial instability than in the past and that some level of financial stress—particularly when it’s able to help alleviate some excesses—could be a feature and not a bug of central bank thinking.

In our view, recent decisions by the Reserve Bank of Australia (RBA) and Bank Negara Malaysia (BNM) to resume monetary tightening following a short pause in their respective rate-hike cycle point in that direction and underline the upside risks to global monetary policy forecasts.

RBA and BNM deliver interest-rate hikes in May (%)

Chart of policy interest rates in Australia and Malaysia. The chart shows that official interest rates in both these economies have risen sharply in the past year.
Source: Reserve Bank of Australia (RBA), Bank Negara Malaysia (BNM), Macrobond, Manulife Investment Management, as of May 10, 2023.

RBA: a pause, followed by a surprise hike

Having only just paused its tightening cycle in April, the RBA surprised markets with a 25 basis points (bps) rate hike on May 5. Notably, the central bank also revised its growth and inflation outlook lower.

Although the RBA acknowledged that financial conditions in Australia have tightened a little further in recent months, the central bank highlighted two factors that led it to resume tightening: First, prices remain elevated, and it could be some time before inflation could return to target, and second, that house price inflation has stopped falling. Crucially, the RBA went on to say that some further tightening “may be required.”

Australia has one of the highest household debt-to-disposable income ratios in the developed world—it stood at around 211% as of 2021—and the country’s property sector is highly sensitive to changes in interest rates. Both of these factors make the Australian economy especially vulnerable to high interest rates. 

BNM: preempting risks that can arise from an extended period of low interest rates

Following back-to-back pauses at the last two meetings (January and March), BNM’s monetary policy committee unexpectedly hiked the overnight policy rate (OPR) by 25bps on May 3. Market participants, who had been expecting a pause and had even started to price an end to the tightening cycle (including a near-term rate cut), were caught off guard.

There were no changes to BNM’s assessment of the country’s outlook for growth and inflation, although the rate-setting committee cited a new consideration in its decision to tighten again—"to prevent the risk of future financial imbalances.”

In taking a data-dependent approach, BNM has left the door open to further normalization, although the central bank took pains to note that its monetary policy stance remained slightly accommodative even after the most recent rate hike.

In terms of economic fundamentals, household and corporate debt ratios in Malaysia are among the highest in the Asia-Pacific region, making the economy particularly vulnerable to high interest rates. That said, BNM’s rate-setting committee argued that a higher OPR is needed “to prevent problems that can arise from long periods of low interest rates (e.g., too much borrowing)."

"We continue to believe that the market is premature in its pricing of the dovish pivot, both in terms of timing and magnitude."

Factors driving central banks to hike rates

Hindsight is perfect. Having put interest rates on hold in the previous months, the RBA and BNM found themselves in a position where their respective decisions to pause tightening were interpreted by the markets as proof that monetary tightening has ended and that rate cuts were imminent. This led to an improvement in market sentiment even as inflation—while moderating—remained stubbornly elevated and showed few signs that it was going to return to target within a reasonable timeframe.

Unsurprisingly, policymakers at both central banks took a cautious view of these developments, understanding that they could exacerbate financial risks, particularly in an environment in which wage inflation persists and evidence of significant downside risks to the global economy remains limited. In our view, they’re unlikely to be alone. Their peers at the U.S. Federal Reserve (Fed) and other global central banks are likely to ponder on the same few factors, which we believe will inform the global interest-rate policy path going forward.

We continue to believe that the market is premature in its pricing of the dovish pivot, both in terms of timing and magnitude. In our view, markets need to reassess the central bank put for asset prices. Naturally, this extends to our view on market pricing of Fed rate cuts as soon as July and where we see the risks to our view of a rate cut later in 2023.

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Sue Trinh

Sue Trinh, 

Former Co-Head, Global Macro Strategy, Multi-Asset Solutions

Manulife Investment Management

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