Surprise drop in July CPI; core inflation still high

[SINGAPORE] Forget the tame headline number - Singapore's core inflation story is still a concern.

While consumer price inflation eased further to 1.2 per cent in July - mainly due to lower car prices and reflecting a high base a year ago - core inflation crept up to 2.2 per cent on the back of higher services inflation. Core inflation strips out accommodation and private road transport costs.

With core inflation projected to stay elevated at 2-3 per cent in 2014, economists agree that the central bank will stick to its current monetary policy stance at its next review in October, allowing for a gradual appreciation in the trade-weighted Singapore dollar.

July's benign inflation rate surprised private-sector economists, who were expecting an unchanged reading from June's 1.8 per cent. In fact, of the 21 analysts polled by Bloomberg before the Department of Statistics released the data on Monday, only one projected an increase of below 1.3 per cent.

The key driver behind last month's easing was the 1.6 per cent drop in private road transport costs, following the 2.8 per cent increase in June.

Said the Monetary Authority of Singapore (MAS) and the Ministry of Trade and Industry (MTI) in joint comments: "This mainly reflects the high base last year when COE (Certificate of Entitlement) premiums surged, while petrol pump prices also rose at a slower pace of 3.1 per cent, compared to 6.4 per cent a month ago."

Given the soft housing rental market, accommodation costs were largely unchanged last month, after rising by 0.5 per cent in June. On a month-on-month basis, accommodation costs fell by 2 per cent, largely reflecting the disbursement of Service & Conservancy Charges rebates for HDB households.

Since July's low inflation reading was largely due to a drop in car prices and the stabilising of accommodation costs, economists including CIMB's Song Seng Wun cautioned against getting carried away by the "misleading" headline number.

"After all, we don't go out and buy a car or rent a home everyday. For the average household, core inflation is still more important," said Mr Song.

Added UOB's Francis Tan: "People shouldn't react to July's 1.2 per cent (figure) - it's impacted by private road transport costs, and base effects mean this will swing up and down. What's more important is core inflation, because it better represents the broad underlying price trends in the economy. And as we saw in July, services inflation will still edge upwards slowly - especially in the more labour-intensive segments."

Services inflation was higher at 2.5 per cent last month, compared to 2.2 per cent in June. This was led by stronger increases in pre-school fees, medical treatment costs, and holiday travel expenses.

The pick-up in services inflation meant that core inflation inched up to 2.2 per cent in July from 2.1 per cent a month ago. Economists expect this to continue, given the structurally tight labour market.

Said CIMB's Mr Song: "I'm a bit surprised that the pass-through of costs has been relatively mild so far. Perhaps it's competitive pressure that has been holding firms back from passing on their higher costs to consumers - but I don't think we'll see that for much longer."

Bank of America Merrill Lynch economist Chua Hak Bin expects core inflation to remain above 2 per cent as wages rise, citing recent moves to raise the monthly wages of cleaners, security guards, and nurses, as well July's foreign worker levy hikes.

And while food inflation eased in July to 3 per cent from June's 3.2 per cent - due to a more moderate rise in the prices of non-cooked food items and prepared meals - OCBC's Selena Ling thinks seasonal increases in food prices will exert further upward pressure on core inflation in the second half of this year.

At least two banks cut their 2014 headline inflation forecasts on Monday after the data release: OCBC now expects inflation to come in at 1.5 per cent (from 1.7 per cent previously), while UOB thinks 1.6 per cent is likely (from 2 per cent before).

As for official estimates, the MAS and MTI reiterated their inflation forecasts for 2014 - headline inflation is projected to come in at 1.5-2 per cent, while core inflation will "stay elevated" at 2-3 per cent.

Indeed, economists expect the divergence between headline and core inflation to expand further in the coming months.

Said Credit Suisse's Michael Wan of the monetary policy implications: "The main concern for MAS going forward continues to be the tight labour market and the prospect of rising wage growth feeding into core inflationary pressures, in our view. As such, we believe MAS will continue to keep its tight exchange rate stance on hold in October."