Singapore dollar tipped to strengthen even as MAS waits to tighten monetary policy

SINGAPORE'S central bank has left the door open to policy normalisation at its next half-yearly review in October, as economic growth picks up.

But analysts expect the Monetary Authority of Singapore (MAS) to welcome a mild appreciation of the Singapore dollar nominal effective exchange rate (S$NEER) by the market - regardless of whether policy settings are tweaked this year or next April.

To be sure, policy tightening remains unlikely this year, after the MAS said on Wednesday: "As core inflation is expected to stay low this year, MAS assesses that an accommodative policy stance remains appropriate."

As expected by economists, the latest monetary policy statement left unchanged the mid-point and width of the S$NEER policy band, as well as its neutral pace of appreciation.

But there is room for the market to price in de facto S$NEER appreciation, which Standard Chartered (StanChart) analysts Edward Lee, Divya Devesh and Jonathan Koh said typically happens ahead of normalisation.

"We expect the S$NEER to trade in the strong half of the policy band in the coming quarters," they wrote, predicting "scope for further upside for the S$NEER from current levels".

The Singapore dollar (SGD) stood at 1.336 against the US dollar (USD) around 5pm on Wednesday, stronger by a hair from 1.34 in the morning.

Indeed, Citi analysts Kit Wei Zheng, Ang Kai Wei and Gaurav Garg observed the S$NEER "has already been trending higher since February 2021 despite a strong USD backdrop".

The MAS' stance and global price pressures "will likely to fuel a further upward crawl in the S$NEER in coming months, even without further nudging", they wrote in a report.

Pointing to the central bank's foreign currency purchases in the back half of 2020, Mohamed Faiz Nagutha, an economist at BofA Global Research, said: "Despite this heavy intervention to prevent excessive SGD appreciation and FX pass-through creating deflationary expectations, the MAS is indicating that it is still allowing some SGD appreciation against USD and other reserve currencies."

But Barclays economist Brian Tan said in an e-mail to The Business Times: "If anything, risks are skewed to a lower S$NEER from current levels in 2021... We do expect the S$NEER to gain further, but in 2022."

Mr Nagutha also asked how long the S$NEER could maintain its strength. Trading in the upper half of the band "requires sustained evidence of the economy growing above trend and core inflation breaching its historical average", he remarked.

While the MAS said on Wednesday that the negative output gap in the economy will narrow over 2021, and core inflation should rise gradually, it still expects output to fall below potential this year, with core inflation to stay below its historical average.

The central bank had eased its exchange rate-based monetary policy in end-March 2020, taking the unusual step of both cutting the slope to zero and lowering the centre of the band amid a worsening Covid-19 outbreak.

"Given the ample space within the current band and below-trend inflation, MAS does not appear to be in a rush to tighten its formal policy settings," said BofA's Mr Nagutha.

The MAS raised its all-items inflation forecast to between 0.5 per cent and 1.5 per cent, on higher-than-expected increases in private transport and accommodation costs - up from -0.5 per cent to 0.5 per cent before.

But the forecast for core inflation, which is a key gauge for MAS policy, was held steady at zero to 1 per cent.

OCBC chief economist Selena Ling said core inflation "would need to further normalise back to 1 per cent to 2 per cent range to firmly call for a recalibration of monetary policy settings".

Still, watchers stressed how the MAS did not repeat its earlier statement that accommodative policy may be needed "for some time". That suggests a potential tightening in October in the event of rapid reflationary pressure, they deduced.

"The risk is that domestic price pressures - gauged proximately via employment and industrial rentals - could come in stronger than forecast," wrote JP Morgan analysts Ong Sin Beng and Arthur Luk, citing Singapore's better-than-expected first-quarter growth and "stronger recovery path for the rest of the year".

Citi analysts also flagged the potential news of a Goods and Services Tax (GST) rate hike as a price driver that could justify normalisation.

In that case, the MAS could adjust the policy band slope in October - what UOB economist Barnabas Gan called "a symbolic appreciation (estimated at 0.5 per cent) to its S$NEER gradient", up from zero now.

The StanChart team said "we do not expect an upward re-centring on its own", but added: "Should core inflation accelerate unexpectedly, the MAS may sanction a dual tightening."