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Malaysia's economic slowdown is prompting investors to bet the central bank will lower borrowing costs for the first time since 2003 by March as inflation cools, according to interest-rate futures contracts.

The Kuala Lumpur interbank offered rate, a benchmark for lending between banks, fell to 3.15 percent, according to the futures contract for March settlement. That's 50 basis points lower than the 3.65 percent local banks charge each other for three-month loans currently. The Klibor is fixed at 11 a.m. daily based on the average of rates contributed by local banks. A basis point is 0.01 percentage point.

“Economic data suggests growth has slowed at a faster pace than expected and the central bank should be looking at a series of cuts as they are now generally pro-growth,'' said Kit Wei Zheng, an economist based in Singapore at Citigroup Inc. “The futures are an indicator but we think they may not be predicting enough cuts.''

Bank Negara Malaysia has kept its overnight policy rate unchanged since raising it by a quarter-point to 3.5 percent in April 2006. The central bank last trimmed borrowing costs in May 2003 when the benchmark, then known as the intervention rate, was lowered to 4.5 percent from 5 percent. It introduced the overnight rate as a benchmark in April 2004, without altering the policy bias.

Citigroup expects the central bank to cut the overnight rate to 3.25 percent at its final monetary policy meeting this year on Nov. 24. The rate may fall to 2.75 percent by March next year, Kit predicts.

Recession Signals

Traders increased bets Bank Negara will cut interest rates after a government report on Nov. 11 showed industrial production fell 1.7 percent in September, the first decline since March 2007. Governor Zeti Akhtar Aziz has said the central bank has the flexibility to lower rates if needed as inflation eases.

Malaysia on Nov. 4 cut its growth forecast for 2009 to 3.5 percent, the slowest in eight years, from 5.4 percent, citing an exports slowdown. Growth may slow to 5 percent this year from 6.3 percent in 2007, Deputy Prime Minister Najib Razak said then creditscore.

A Cabinet Office report today showed Japan's economy contracted 0.4 percent in the third quarter, joining Singapore in slipping into a recession. Both countries accounted for 25 percent of Malaysian exports in the first nine months this year, according to trade ministry data.

“The authorities have opened the door for a rate cut, given that growth and inflation have eased,'' said Lum Choong Kuan, head of fixed-income research at CIMB Investment Bank Bhd. in Kuala Lumpur. “The timing and quantum are still debatable.''

Reliability

Still, the futures may be deceiving. The central bank kept its policy rate on hold, even as the bets switched from a 100 basis-point increase in June to a 25 basis-point cut just before the last monetary policy meeting on Oct. 24.

Traders bet a full percentage point increase in rates as a rally in crude oil prices pushed Malaysian inflation to a 26- year high of 8.5 percent in July. The odds for a rate cut gained momentum after Lehman Brothers Holdings Inc. filed for bankruptcy on Sept. 15, stoking a credit-market crisis.

“I wouldn't pay too much attention to the futures, given what happened to expectations in the past,'' said Ray Choy, head of debt markets research at RHB Research Institute in Kuala Lumpur. “An interpretation based on the futures alone will be inaccurate'' because the contracts lacked liquidity, he said.

A total of 14,778 Klibor futures contracts were traded in October, with 44,437 in open interest outstanding. The monthly average in 2007 was 19,942 contracts with 64,913 open-interest positions, according to data published by Bursa Malaysia Bhd.

Three-year government bonds yield 3.59 percent versus the 3.65 percent for three-month Klibor, showing that current market trading hasn't fully priced in any interest-rate cut, Choy said.

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