KUALA LUMPUR: The odds for Bank Negara Malaysia to ease its monetary policy have increased following the near-term risks from United Kingdom's exit from the European Union, says UOB Bank.
There is room to cut rates given real policy rates of 0.5 per cent (nominal Overnight Policy Rate at 3.25 per cent less estimated 2016 inflation).
Economist Julia Goh however said the timing of a cut is uncertain as it is hard to assess the immediate and long term effects on Malaysia.
The case for a cut is stronger if broader contagion risks arise.
"Given that exposure to UK is small, the direct effects on trade is minimal while slower EU growth will have more meaningful impact on Malaysia's trade,"she said in a report today.
Businesses could hold back investment decisions, weighing on growth.
Reversal of capital flows, liquidity tightness and Ringgit weakness is another key risk but these are yet to be seen.
Downside risks to growth would stem from a potential recession in UK and derailed recovery in EU.
Malaysia's direct exposure to UK is relatively small (1 per cent of total trade, 1.7 per cent of tourist arrivals, 4.3 per cent of foreign direct investment or FDI stock).
"More crucial is to watch for effects on rest of EU which Malaysia has a larger exposure (9.9 per cent of total trade, 2.6 per cent of tourist arrivals, 27 per cent of FDI stock),"she said, adding that there is a more significant impact will come if growth in the broader EU is affected.
Goh cited the most affected sectors are banking and financial sectors.
UK banks have sizeable claims counterparties in Malaysia and they have up to 25 per cent of total claim by foreign banks in Malaysia.
"The biggest risk is a reversal of capital flows, particularly given that foreigners hold 48.7 per cent of total outstanding Malaysian government bonds as at May 2016."
Malaysia has been increasing its holdings of UK assets (4.7 per cent of direct investment abroad) as part of its asset diversification strategy.
"Portfolio values will be affected as property prices drop and the pound weakens. For companies, earnings erosion also to follow as markets turn jittery,"she said, adding that the uncertainty could deter investments in the UK markets.