Malaysia's central bank raised its key interest rate for the first time in more than three years on Thursday, as widely expected, to help temper inflation and rising consumer debt.
Strong domestic consumption has helped underpin growth in the Southeast Asian economy, but rising household debt levels are posing an increasing risk when global interest rates rise.
Bank Negara Malaysia (BNM) hiked its overnight policy rate by 25 basis points to 3.25 percent, after keeping it steady since mid-2011. It had hinted of a monetary policy tightening to counter the "build-up of financial imbalances" at its last meeting in May.
On Thursday, it said that the "normalization" of monetary policy was needed to ward off risks of financial and economic imbalances that undermine growth. It said that its new stance remained supportive of the economy, which it saw showing continued strength in exports and private sector activity.
"Going forward, the overall growth momentum is expected to be sustained," it said in its statement accompanying the decision.
The economy grew at a robust pace of 6.2 percent in the first quarter from a year earlier. The majority of economists polled by Reuters had anticipated a 25-basis-point hike as economic conditions at home and abroad improve and inflation stays high.
Many analysts expect interest rates to rise one more time before the end of the year due to inflationary pressure and robust growth. Industrial output grew at its fastest pace in three months in May, data released earlier on Thursday showed.
"We expect another hike in September because the momentum is still there," said Wellian Wiranto, an economist at OCBC Bank in Singapore. "Even after the hike, there's a risk that inflation will pick up."
Economists had expected the rate hike following strong growth and the continued increase in housing loan approvals. Property loans form more than half of the country's household debt, which is now at a lofty 86.8 percent of GDP.
Malaysia's household debt has risen more than 25 percentage points in just 6 years, as domestic consumption grew on loose credit.
"Many are treating the property market as the new deposit box that pays higher returns than what banks are offering," DBS said in a recent research note.
Inflation rose to 3.2 percent in May in contrast to 1.8 percent in June 2013, before the government imposed higher electricity tariffs, reducing fuel subsidies and eliminating the sugar subsidy.
"Demand driven inflation remains contained," the central bank added.
Inflation is expected to remain elevated with a possible fuel price increase later this year and the implementation of a goods and services tax in April 2015.
"The bigger question from the market is what BNM does next," said Euben Paracuelles, an economist at Nomura in Singapore.
"There are clues from the policy statement, they've left the door open for more rate hikes this year. Their assessment in growth is pretty upbeat, but there is still the risk of financial imbalances."
The ringgit, up around 2.15 percent against the dollar since the central bank signaled tighter policy on May 8, turned weaker on Thursday as investors cut bullish positions.
Other regional central banks are also keeping watch over inflation due to strong domestic demand.
The Philippines is expected to raise interest rates at the end of July after more than six months of rising inflation. Indonesia held its key rates steady on Thursday while Thailand kept its interest rate steady last month as its military government tries to get the economy back on track.