Malaysia rate cut was likely influenced by bank liquidity stress

Malaysia's central bank recently loosened monetary policy. While an appreciating currency is lessening the risks of imported inflation, and policymakers want to cushion the economy against Donald Trump's trade war, the Bank Negara Malaysia (BNM) also probably factored in stresses facing the banking system.

The BNM cut its key rate by 25 basis points to 2.75%, citing moderate inflation and the absence of strong domestic demand pressures. Less than two months earlier, however, the central bank cut the statutory reserve requirement (SRR) for commercial banks in half, to just 1%.

The SRR stipulates the amount of cash that lenders must keep in reserve. The reduction -- the first since the start of the pandemic in 2020 -- would inject more than the equivalent of USD 4 billion into the banking system, the BNM said at the time.

Our subsequent charts explore Malaysia's monetary conditions. Liquidity in the banking system has been under pressure as loan growth continues to outpace deposit growth, while the liquidity absorbed by the BNM has been declining.

The stronger ringgit likely provided additional room for policy easing, given that its appreciation had effectively tightened monetary conditions. As our final chart shows, the BNM no longer needs to borrow as much foreign currency and has been able to gradually wind down its dollar borrowing, as expressed by short positions in the FX swaps market.

Downside risks persist for the Malaysian economy. Besides trade concerns, commodity production and sentiment have weakened. More positive trends include household spending, sustained investment in multi-year projects and other pro-growth initiatives.