Malaysia Interest-Rate Swaps Reach Two-Year High; Ringgit Falls

April 3 (Bloomberg) -- Malaysia’s one-year interest-rate swaps reached the highest level since 2011, signaling the central bank may increase borrowing costs at least twice in 12 months as inflation accelerates.

Consumer-price gains quickened to a 32-month high of 3.5 percent in February, after the government raised fuel and power tariffs to rein in the fiscal deficit. Prime Minister Najib Razak will introduce a consumption tax in 2015 and targets a 15.6 percent reduction in subsidies to 39.4 billion ringgit ($12 billion) in 2014 for items such as sugar and cooking oil, according to a finance ministry report released in October.

“Inflation is rising fast due to administrative measures and the forthcoming goods and services tax,” said Wee-Khoon Chong, Singapore-based head of rates strategy for Asia ex-Japan at Nomura Holdings Inc. “We expect Bank Negara Malaysia to hike twice this year to 3.50 percent from 3 percent.”

One-year swaps held at 3.50 percent as of 5:05 p.m. in Kuala Lumpur, after rising two basis points to that level late yesterday, according to data compiled by Bloomberg. That’s the highest since July 2011. The contracts advanced 11 basis points this year.

The yield on the 3.172 percent government bonds maturing in July 2016 was steady at 3.34 percent. The ringgit dropped 0.4 percent, a second day of declines, to 3.2839 per dollar.

Policy Tool

Bank Negara Malaysia has kept it benchmark interest rate at 3 percent since May 2011 even as inflation accelerated. It next meets to review policy on May 8.

“Given the nature of factors behind the increase in inflation, monetary policy is not the best policy tool to manage the situation,” the central bank said in its annual report in March. “Nevertheless, higher cost-push inflation could lead to inflation expectations becoming unanchored and could, in turn, lead to wage growth that is not consistent with productivity growth.”

Southeast Asia’s third-largest economy may grow 4.5 percent to 5.5 percent in 2014, after expanding 4.7 percent last year, the central bank said in the March 19 report.

Three-year Malaysian sovereign debt offers a real yield of minus 0.12 percent, after accounting for inflation, according to data compiled by Bloomberg.

“The real interest rate has been negative, and Bank Negara won’t tolerate that for long,” said Kumar Rachapudi, a Singapore-based strategist at Australia & New Zealand Banking Group Ltd., who predicts the central bank will tighten policy by 50 basis points in the second half.

Bank of America Merrill Lynch has moved to receive two-year Malaysian swaps from the five-year tenor, and still wants to position for a less hawkish stance by Bank Negara than what’s been priced in, Hong Kong-based strategist Albert Leung wrote in a research note yesterday.

One-month implied volatility in the ringgit, a measure of expected moves in the exchange rate used to price options, rose four basis points, or 0.04 percentage point, to 6.68 percent.

To contact the reporter on this story: Liau Y-Sing in Kuala Lumpur at yliau@bloomberg.net

To contact the editors responsible for this story: James Regan at jregan19@bloomberg.net Simon Harvey