Unabated inflation could tip MAS into tightening: economists

Singapore

A TIGHTENING of monetary policy - although not the base case at this point - cannot be ruled out at the central bank's next policy meeting in April, especially if core inflation continues to rise and becomes a threat to price stability, economists say.

Yesterday, the Monetary Authority of Singapore (MAS) renewed its commitment to keep the local currency on a rising track - surprising no one by maintaining the "modest and gradual" appreciation path of the Singapore dollar NEER (nominal effective exchange rate) policy band.

Of the 21 economists polled earlier by Bloomberg, 19 had expected the central bank to leave the slope, width, and centre of the policy band unchanged - a policy stance which has been in place since April 2012.

"This policy stance is assessed to be appropriate, taking into account the balance of risks between external demand uncertainties and rising domestic inflationary pressures," said MAS in its second and final monetary policy review for 2013.

Even though imported inflation is likely to remain muted - thanks to spare production capacity in the advanced economies and ample supply buffers in commodity markets - MAS flagged further upward pressures on core inflation in the months ahead.

"The pass-through of domestic costs to prices of consumer services could intensify, given the rising cost pressures firms are facing from business rentals, COE (certificate of entitlement) premiums for commercial vehicles, and labour costs," said MAS in its four-page monetary policy statement released yesterday.

The government projects that headline inflation for 2013 will come in at the upper half of the 2-3 per cent forecast range; for 2014, it expects headline inflation to rest between 2 per cent and 3 per cent.

Economists such as Leif Eskesen of HSBC and Joey Chew of Barclays picked up on MAS's hawkish stance. Said the latter: "The MAS de-emphasised the drop in headline and core inflation in Q2, and instead pointed to the recent pick-up in July-August as foreshadowing further rises in the quarters ahead."

Coupled with a tight labour market, the central bank said that core inflation - which excludes costs of accommodation and private road transport - is expected to be 1.5-2 per cent in 2013, and rise to 2-3 per cent in 2014. With upside core inflation risks looming, economists from Nomura, Citi, DBS and UOB say that a tightening of monetary policy in April could be on the cards - particularly if prices rise beyond the government's comfort zone.

Said Nomura analysts in a report: "Overall, the statement should raise market expectations of the MAS shifting towards an even tighter (foreign exchange) policy stance at the April 2014 meeting."

Added Citi economist Kit Wei Zheng: "Though not our forecast, with the possibility that core inflation may breach the MAS's implicit 2-2.5 per cent tolerance threshold in 2014, slope steepening in April 2014 cannot be ruled out, especially if growth uncertainties subside."

Calling such a scenario "definitely possible", UOB economist Francis Tan said: "It would have to be fuelled by something completely unanticipated, like if oil prices suddenly spike up due to renewed political tensions in the Middle East. Then the MAS will probably move in to tighten the Singapore dollar NEER."

Still, Mr Tan and DBS's Irvin Seah said that such a scenario carries only a low risk at this point, and they still expect the central bank to stand pat with its policy come April.

Added Mr Chew of Barclays: "Barring unexpected significant shocks to growth and inflation, I think we're in the right stance in the medium term. Even if inflation does pick up, as we expect, I think MAS will not want to overreact to overcompensate for (an increase in) inflation. Some of it is structural and needs to happen for there to be a more efficient allocation of resources.

"Singapore has been importing a lot of cheap labour for services since 2000, and that needs to change. So some of this inflation is okay and prices will need to reflect that reality."

Going forward, economists expect the Singapore dollar to strengthen, albeit selectively.

Said Mr Tan of UOB: "Generally, we'll still see our currency getting stronger against regional currencies - but not against the renminbi since that has been appreciating quite a bit. Also, when QE tapering happens eventually, we'll see strength back in the US dollar as well."