Malaysia’s economy registered moderate growth of 2.9% in 2Q2023 (1Q2023: 5.6%), presaged by weaker performance of the external sector. Sustained economic expansion over two consecutive quarters has kept growth on track towards the official year-end gross domestic product (GDP) target of 4%-5%. Private consumption and recovering tourism activities remained key drivers, offsetting the weaker external sector.

After consecutive months of trade contraction, exports slowed further to -13.1% in July, dragged by a double-digit fall in palm oil and petroleum products as well as exports to ASEAN partners. Softer demand from key partners, lower commodity prices and the global technology downcycle could weigh on the export outlook in the coming months.

Foreign investor sentiment appears to have improved in July, as positive foreign inflows in the local equity market marked a reversal from 10 consecutive months of net selling. On the bond market, the negative yield spread between Malaysian Government Securities and US Treasuries widened further to 38 bps in August amid aggressive US rate tightening. The negative spread, in our view, could be a source of volatility in the short term. However, the rhetoric on US monetary policy should turn dovish over time, eventually raising interest in emerging markets.

The July Federal Open Market Committee minutes suggest that more rate hikes might be needed to bring down inflation. However, the below-market expectation data on non-farm payrolls suggest a potential softening of the labour market, which could set the stage for a turn towards a dovish narrative. Looking ahead, we believe that the tightening cycle in the advanced economies will conclude as early as 1H2024, albeit at a different pace according to their respective economic conditions.

We maintain our 2023 inflation forecast at 2.8%, with the easing inflation trend expected to continue into 2024 at 2.5%. In view of this, Bank Negara Malaysia is likely to maintain the overnight policy rate at 3.00% for the rest of the year. Overall, tighter monetary conditions and a challenging external environment could constrain domestic growth ahead, which was reflected in the moderation of the 2Q2023 GDP. For now, we maintain our forecast for full-year 2023 GDP growth at 4.2% (2022: 8.7%).