In a surprising and unexpected move, Bank Negara Malaysia (BNM) announced the reduction of the overnight policy rate (OPR) by 25 basis points to 3% at the Monetary Policy Committee (MPC) meeting on July 13, 2016.

BNM had not reduced the OPR since 2009, when it was at a record low of 2%.

“The ceiling and floor rates of the corridor for the OPR are correspondingly reduced to 3.25% and 2.75% respectively,” BNM stated in its release.

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What is OPR?

The OPR is interest rate at which a bank lends to another bank, which is set by BNM. This rate has an effect on the country’s employment, economic growth and inflation. It is an indicator of the health of a country’s overall economy and banking system.

Why did BNM reduce the OPR?

According to the statement released by BNM, the OPR was reduced in light of the rising risks from Britain’s withdrawal from the European Union (EU), also known as Brexit.

The central bank decided to cut the rate due to the uncertainties in the global environment, which could negatively impact Malaysia’s growth prospects. The rate reduction consequently also lowered inflation forecasts for this year.

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Inflation forecasts are lowered to 2% to 3% in 2016, compared to an earlier projection of 2.5% to 3.5%, and are expected to continue to remain stable in 2017.

“Looking ahead, there are increasing signs of moderating growth momentum in the major economies. Global growth prospects have also become more susceptible to increased downside risks in light of possible repercussions from the EU referendum in the United Kingdom.

“International financial markets could also be subject to greater volatility going forward. In this light, global monetary conditions are expected to remain highly accommodative,” BNM said in a statement.

According to economists, this move was a pre-emptive move to mitigate the increasing downside risks to Malaysia’s economic growth.

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“We sense that Bank Negara is increasingly concerned about the external downside risk impact on Malaysia’s exports and foreign investment inflow,” said Manokaran Mottain, chief economist of AllianceDBS Research.

This pre-emptive move is expected to spur private consumption (52% of Malaysia’s gross domestic product) growth so it will not fall below BNM’s projected 5.1% expansion this year (versus 6% last year). Hence, this will offset the expected weakness in exports and investment growths, he added.

However, this move has caught many experts by surprise.

According to Standard Chartered Global Research, though they have been making a non-consensus call to cut the OPR since the fourth quarter last year due to the deteriorating fundamentals, BNM remained neutral in the last Monetary Policy Committee (MPC) held in May.

“This goes against the typical process, where the central bank communicates a potential change in stance before it sanctions a change,” it said.

How will it affect you?

So, what does this mean to Malaysians?

The 25 basis points reduction in borrowing rates, consumers will be able to see a hike in their disposable income due to the reduction in interest payments. What this means is, consumers will have more cash on hand to spend, which will likely spur the domestic economy.

Any changes will impact floating rate loans which are common for mortgages. When there was an increased in OPR, there was a knock-on effect on the rates charged by banks for home loans for the simple reason that banks adjust their lending rates by a similar quantum when OPR changes. The same effect will likely happen when the rate is cut.

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For example, if the banks decide to stick to their current margins, and the Base Rate (BR) reduces by 25bps (0.25%) new and existing loan (variable rate) borrowers will see a reduction in their monthly repayment.

Here’s an example of how it would affect you:

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Based on the example above, the 25 bps reduction will result in RM26,460.60 savings over a 30-year loan tenure. Borrowers will be able to see about RM73.50 reduction in their monthly repayment based on the example above. Over the loan period, you can see a savings of 6% and a monthly savings of close to 3%.

Though this seems like good news for borrowers, the rate cut may also have an impact on savings rate.

How will it affect the country?

The news of OPR reduction gave the stock market a boost, especially property counters which had been sluggish lately.

After the announcement of the OPR cut, the FBM KLCI closed up 6.42 points or 0.39% to 1,660.39, led by UOA Development REIT, which jumped 30 sen to RM2.49 with 7.50 million shares done.

The OPR cut also lent support to the Malaysia Ringgit, which has jumped to 3.96 to the US dollar, and expected to strengthen further to around 3.95.

Against the Singapore dollar, the ringgit rose to 2.9403/9449 from 2.9446/9492, while it improved against the yen from 3.8039/8098 to 3.8015/8081. On the other hand, the ringgit rebounded higher against the British pound from 5.2637/2715 to 5.1967/2049, but eased against the Euro to 4.3940/4008 from 4.3889/3960 yesterday.

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Banks will likely be negatively impacted by the BNM’s decision, with the already challenging economic environment. Their margin will be further compressed with the lower benchmark interest rate.

However, according to Kenanga Research, Malayan Banking Bhd (Maybank), AMMB Holdings Bhd (AmBank) and Affin Holdings Bhd are likely to be the least affected by the downward revision in the OPR.

These banks are believed to be able to mitigate this impact better, because their fixed rate lending comprises around 30% of their total loan portfolio (versus the industry average of 24%).

On the other hand, RHB Research said another round of OPR cut this year will not be shocking.

“If economic growth continues to slow more than expected, this may cause the central bank to reduce the OPR by another 25bps in the coming meetings.

However, it added that it would be sensible for BNM to adopt the wait-and-see approach if performance of the economy does not stray too far from forecasts.

Though the reduction in OPR comes as a surprise, it does mean more disposable income for consumers.

However, with the current uncertain economy, consumers must consider using the extra cash wisely.
This article is contributed by iMoney.my, Malaysia's leading financial comparison website. To compare and apply for the best financial products, such as credit card, home loans and personal loans, visit www.iMoney.my