Strong economic growth and steadily rising inflation have raised the odds that Malaysia's central bank could hike rates for the first time in three years on Thursday.
"Malaysia is certain to begin normalizing monetary policy soon, and the first rate hike may come as early as this week," said Matthew Circosta, an economist at Moody's Analytics.
"The central bank (Bank Negara) has struck a hawkish tone in recent policy meetings, appearing to build up financial markets and the public for a rate increase," he said. Malaysia's benchmark interest rate currently stands at 3.0 percent.
Southeast Asia's third-largest economy grew a faster-than-expected 6.2 percent in the first quarter, thanks to strong exports and consumer spending.
Meanwhile, inflation has been elevated in recent months as the effects of the government's fuel subsidy cut from last September filters through the economy. Malaysia's consumer price index in May rose 3.2 percent from a year earlier.
In an effort to reduce the budget deficit, the subsidy on petrol was cut by 20 Malaysian sen (6 cents) to 2.10 ringgit per liter. The subsidy on diesel was reduced by the same quantum to 2 ringgit per liter.
DBS economists, who also expect the central bank to begin the interest rate normalization process this week, say this is a step in the right direction given that real policy rate has been in negative territory and can't remain so for long amid high inflation and strong growth.
Financial imbalances are also in the central bank's sights and rate hikes are needed to avoid asset bubbles after a buildup in household debt, say economists.
The ratio of household debt to gross domestic product (GDP) rose to 86.8 percent by the end of 2013, a level regarded as "unhealthy", up from 72.4 percent in 2009.
Too close to call?
While economists agree the central bank is poised to hike rates soon, the timing of the rate hike remains a source of debate.
Tushar Poddar, economist at Goldman Sachs expects Bank Negara to wait until September to tighten monetary policy.
He argues that the slight softening in inflation to 3.2 percent in May from 3.5 percent in March could give the central bank more time before hiking rates.
In addition, Poddar notes that commentary from the central bank was less hawkish in June compared with the previous month, with comments from Governor Zeti Aziz indicating that measures to contain household debt were sufficient for now and that policymakers did not want to over-adjust as the targeted macro-prudential measures were taking effect.
This was a step-back from the more hawkish in tone at Bank Negara's May policy meeting when the central bank said, "going forward, the degree of monetary accommodation may need to be adjusted to ensure that the risks arising from the accumulation of these imbalances would not undermine the growth prospects of the Malaysian economy".
Credit Agricole also expects Bank Negara to keep policy rates unchanged, but notes that "it's a close call for as the central bank sounds increasingly hawkish."