In a post-pandemic era, most economies start to normalise or tighten monetary policy rates amid improving domestic economic activities and rising inflationary pressure. The US Federal Reserve is set to end its fund’s rate at 3.50% by end of this year, higher than 2.50% in 2019. Bank of England further raised its interest rate to 1.75% on Aug-22, the highest since 2009. The European Central Bank also surprised the global financial market after raising its interest rate from 0.00% to 0.50% in Jul-22, the first-rate hike since 2011. Reserve Bank of Australia and Reserve Bank of India are also seen tightening interest rates higher than 2019 levels by end of 2022.
The faster pace of the Fed’s tightening monetary policy had caused a strong appreciation of the US dollars and directly
suppressed other currencies. Since 2022 is a post-pandemic year, the pace of monetary policy normalization varies across
countries, mainly to balance economic growth stability, currency fluctuation, and the inflation target. In addition, every
country reopens its domestic economy at different times, hence affecting the growth trajectory and monetary policy normalisation
Fundamentally, Ringgit is on a strong footing underpinned by firming domestic demand, robust external sector, and elevated global commodity prices. The unemployment rate is on descending trajectory, 3.9% in May-22 (2021: 4.5%), slightly higher than the pre-pandemic level 3.4%. Inflationary pressure in Malaysia remains stable, among others thanks to the capped retail fuel prices and other subsidy assistance. In addition, MIDF foresees moderation of food price inflation in 2HCY22 amid slight betterment in domestic food supply and correction in global commodity prices. MIDF is optimistic that Ringgit to appreciate in 2HCY22 and reach RM4.25 per USD by year-end, driven by the strong economic fundamentals and elevated commodity prices.
Broad strength in USD as Fed tightened aggressively. Thus far, the recent weakness in Ringgit was primarily due to
the effect of the broad strength in USD. A more aggressive policy tightening adopted by the Fed and the widening of interest
differentials resulted in stronger demand for USD. As USD appreciated against other major currencies, the US dollar index
(DXY) rose to 108.5 by mid-July 2022, the highest level in 20 years. Consequently, Ringgit was traded in the last 2 weeks
at around RM4.45, the weakest in 5 years. In the first 7 months of this year, Ringgit weakened by -6.4% against the dollar,
from RM4.17 as of end-2021.
Will slower Fed tightening be positive for EM currencies? With the US Fed expected to slow down the pace of its
policy tightening towards the end of the year, MIDF foresees less support for US dollars to strengthen further. In other words, movement in the financial market would pose less drag on EM currencies. In addition, a possible reversal of financial flows towards EM markets and an improved appetite for risk assets will be positive for regional currencies, including Ringgit.
Moreover, EM currencies stand to gain from an improved growth outlook in China in the latter part of the year, after being negatively impacted by the Covid-19 lockdowns re-imposed in 2QCY22. Considering the improved growth outlook and sustained current account surplus, we forecast Ringgit could appreciate and reach RM4.25 by end-2022.
Based on real effective exchange rate (REER), Ringgit remains undervalued. The value of Ringgit at REER even fell further in 1HCY22. Looking at improving growth momentum, elevated commodity prices, and increasing domestic economic activities on the back of economic reopening, MIDF believes the economic fundamentals are more in favor of stronger Ringgit. This explains why Ringgit strengthened against other currencies according to the nominal effective exchange rate (NEER). Ringgit has been strengthening on NEER basis from the recent trough in May-21 when the full nationwide lockdown was imposed last year. Unfortunately, movements in the financial market, which are more sensitive to the US FOMC’s rate decisions, caused Ringgit to weaken specifically against the US dollars