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MAS tightens policy slightly; trade tension risks remain

It will increase the slope of S$NEER policy band, setting the Sing dollar on a modest and gradual appreciation path

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With inflation expected to go up and growth projected to be steady for the year ahead, some economists argue that there is room for the central bank to continue to tighten monetary policy in its October review.

Singapore

SINGAPORE'S central bank moved to tighten monetary policy for the first time in six years, in a measured show of confidence that the economy will continue to grow in 2018 even as trade tensions loom.

The Monetary Authority of Singapore (MAS) said on Friday that it will slightly increase the slope of the Singapore dollar nominal effective exchange rate (S$NEER) policy band, setting the Sing dollar on a "modest and gradual" appreciation path. The width of the policy band and the level at which it is centred will be unchanged.

Most economists interpret the slope to be about 0.5 per cent per annum.

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This is a shift away from the neutral policy stance of zero per cent appreciation maintained since April 2016.

A tighter monetary policy - which corresponds to a stronger currency - counters inflation by making imports cheaper in Sing dollar terms, while exports become more expensive.

The MAS uses the exchange rate instead of interest rates as its main monetary policy tool to strike a balance between inflation from overseas and economic growth. It manages the Sing dollar against a trade-weighted basket of currencies of its major trade partners, allowing the exchange rate to float within an undisclosed S$NEER band.

The MAS regularly reviews the policy band and announces changes, if any, in its bi-annual monetary policy statement (MPS) in April and October. In its April review, the MAS said that the Singapore economy has "evolved as envisaged" since the last October 2017 MPS, and should continue on its "steady expansion path" this year.

However, an escalation of the US-China trade dispute remains a downside risk, which would have significant consequences for global trade, said the central bank.

But despite the uncertainty from ongoing trade tensions, the MAS still went ahead with its "measured adjustment" to the policy stance on Friday to ensure medium-term price stability.

The normalisation of monetary policy came as no surprise to economists, who have been expecting a tightening move on the back of a stronger economy, improved labour market and rising inflation.

But it still prompted a kneejerk reaction in the US dollar/Sing dollar exchange rate. On the news of the monetary tightening at 8 am on Friday, the Sing dollar strengthened to S$1.3085 against the greenback, from S$1.3114 just one minute before. It subsequently pared its gains before closing at S$1.3115.

Some economists noted that the MAS struck a more hawkish tone regarding inflation.

Up till today, the MAS expected core inflation - which strips out accommodation and vehicle costs to get a better gauge of everyday expenses - to stay in the 1-2 per cent range in 2018, while headline inflation is projected to range from zero to one per cent this year.

However, the central bank now sees both core and headline inflation to come in within the upper half of the forecast ranges - the first change to its current projections.

In addition, upward pressures on core inflation are "expected to persist over the course of this year and beyond", underpinned by an improving labour market, according to the MAS.

Maybank Kim Eng economists Chua Hak Bin and Lee Ju Ye said that the more upbeat figures showed "greater confidence" by the central bank on rising inflation, with its emphasis on a gradual rise in domestic sources of inflation.

Bank of America Merrill Lynch (BofAML) economist Mohamed Faiz Nagutha said: "This is a notable shift from the policymakers, but in line with our view that inflation could be at a critical point of inflection and more pervasive than suggested by headline figures."

But with the removal of an explicit forward guidance, economists are split on what the MAS's next move will be.

With inflation expected to go up and growth projected to be steady for the year ahead, some economists argue that there is room for the central bank to continue to tighten monetary policy in its October review.

"There was a nuanced mention that the latest measured policy adjustment takes into account ongoing trade tensions, which may allude to the probability of further moves once the trade situation clears," wrote Standard Chartered economists Edward Lee, Divya Devesh and Jonathan Koh in their report.

They are expecting another 0.5 per cent increase in the slope in October. This is also the expectation by BofAML's Mr Nagutha. Others such as Maybank Kim Eng, OCBC and UOB do not expect further tightening in October.

OCBC economist Selena Ling said that there is "no immediate presumption" that a further move is warranted in the next policy review, unless inflation picks up faster than expected.

While trade tensions were highlighted by the MAS as a potential spanner in the works, economists mostly do not expect this to escalate further into a trade war.

Standard Chartered's Mr Koh said: "We believe the current developments to be posturing, and we do not expect hard measures that will impact trade negatively."

Even as what lies ahead in the October policy review remains up in the air, Morgan Stanley economists Zac Su and Tan Deyi noted that going forward, any increase is "unlikely to return to the 2 per cent plus appreciation per annum seen historically".

"Indeed, a reduced S$NEER slope is here to stay given the structurally lower growth level and slower productivity growth compared to before."

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