Malaysia's producer price index drops 5%

But there is something terribly wrong in the trend.

According to Nomura, producer price index (PPI) declines continued, by 5% y-o-y in December after falling 3.4% in November. PPI inflation tends to lead CPI inflation by about two months, which suggests still-lower CPI inflation in the next few months.

However, this relationship appears to be weakening: CPI inflation has fallen by much less than what PPI declines would normally imply.

Here's more from Nomura:

In our view, this reflects (upward) demand-pull pressures on consumer prices, which strengthened relative to (downward) cost-push pressures.

This in turn reflects still-strong domestic demand, supported by loose fiscal policy. This will likely continue, particularly in the run-up to the elections.

Thereafter, base effects and food supply dynamics could also become much less favorable than last year.

As such, we forecast an increase in CPI inflation to 2.4% in 2013 from 1.7% in 2012, and as a result, Bank Negara (BNM) should begin rate hikes by H2.

We think BNM is still biased toward normalising policy rates to reduce financial stability risks, and this normalization process will likely resume once CPI inflation gathers pace.