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Inflation concerns spurs surprise monetary policy tightening by MAS

Amala Balakrishner
Amala Balakrishner10/14/2021 08:34 PM GMT+08  • 8 min read
Inflation concerns spurs surprise monetary policy tightening by MAS
The central bank's surprise move follows estimates of core inflation staying “close to 2%".
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A need for price stability amid expectations of rising inflation has pushed the Monetary Authority of Singapore (MAS) to tighten its monetary policy settings on Oct 14. The surprise move follows the accumulation in external and domestic pressures, and estimates show that core inflation will stay “close to 2% in the medium-term”.

The metric — which gauges price increments to sectors other than accommodation and private transport — rose to 1.1% on a y-o-y basis between July and August, from 0.7% in 2Q2021. This was in response to a rise in global commodity prices that have since been passed on through electricity and gas tariffs as well as non- cooked food inflation. Meanwhile, the inflation levels in domestic consumer items such as food and beverage services have also inched up on account of higher wages.

MAS’s tightening move involves slightly raising the slope of the Singapore Dollar Nominal Effective Exchange Rate (S$NEER) policy band, up from a flat or zero percent slope previously. At the same time, the slope of the band — which indicates its rate of appreciation — and midpoint have been left unchanged.

With this, the central bank hopes to “ensure price stability over the medium term while recognising the risks to the economic recovery”. The Singapore dollar gained about 0.3% after the announcement to hit a three-week high of $1.3475 per US dollar.

OCBC Bank’s chief economist Selena Ling says the policy concerns “appear to be more persistent” from broad price pressures such as a confluence of supply chain problems, rising surging energy prices and the manpower crunch because of pandemic-related disruptions.

A stronger Singapore dollar means that inflation levels may not be as high as it could be for the local consumer. For instance, it could help to offset some of the rising material costs — which have in turn pushed up the prices of household appliances ranging from laptops, tablets and washing machines, says Song Seng Wun, an economist at CIMB Private Banking.

A firm Singapore dollar, adds Song, would mean that exchange rates may be more favourable against foreign currencies — something that will benefit consumers looking to travel or even purchase goods abroad.

The monetary policy parameters were last tweaked in March last year, to help combat the economic downturn brought upon by the pandemic.

However, the latest move by MAS caught most pollsters by surprise. Most of the analysts polled by Bloomberg had predicted that the MAS would take on a more hawkish tone but wait till April 2022 to tighten its policy stance.

Among those who predicted this move were Phillip Wee and Eugene Leow of DBS Bank. “The decision reflected confidence in the resilience of the Singapore economy and was considered a timely response to pre-empt global inflationary pressures,” says Wee, a senior currency strategist.

Leow, a senior rates strategist, notes that MAS’s “actions are mirroring that of other central banks across the world”. A key takeaway for him is that the MAS is signalling that price pressures are likely to stay elevated for some time. “This sets the stage for another leg of tightening in 2022 if needed,” he adds. Agreeing, OCBC’s Ling says the tone for the next MAS policy meeting in April 2022 would depend on whether the optimism for growth and inflation pans out as expected.

Going forward, the official estimates have put core inflation at near the upper end of the 0% to 1% forecast for 2021, before rising further to between 1% and 2% next year, as the lagging effect kicks in.

Meanwhile, headline, or all-items inflation — which measures the total level of inflation in the economy — is tipped to come in around 2% in 2021, before averaging at 1.5% to 2.5% next year.

A key reason for this is that private trans- port inflation is likely to moderate in 2022 against a slower pace of increase in Certificate of Entitlement (COE) premiums and petrol costs. However, accommodation inflation is expected to remain firm amid construction delays, cautions MAS.

Against this outlook, Bank of America (BofA) Securities economist Mohamad Faiz Nagutha observes that the S$NEER range is likely to shift higher to 1% to 2%, in anticipation of further policy moves. Specifically, the S$NEER may briefly pull towards the lower end of the range at times when the US$ is seemingly stronger.

What this means for investors is there will be more confidence for relative plays in the region such as the outperformance of the Singapore dollar vis-à-vis that of the Thai bhat or Taiwan dollar, which are lagging policy normalisation, explains Nagutha.

Necessary push

CIMB’s Song says MAS’s move marks the start of a new growth cycle for Singapore’s economy. This seems to be a necessary push that comes amid — what some market watchers have called — a seemingly weaker than expected advance estimate for 3Q2021 GDP.

According to the Ministry of Trade and Industry (MTI), Singapore’s GDP was up 6.5% y-o-y in the third quarter. In contrast, the economy surged 15.2% y-o-y in the preceding second quarter, which enjoyed a low-base effect as 2Q2020 was when the “circuit breaker” was imposed, leading to the trough of the pandemic-induced slump last year.

MTI notes that a key push in 3Q2021’s performance was from the construction sector which expanded by 57.9% y-o-y, extending the previous quarter’s 117.5% y-o-y growth rate. Again, this was largely because of the low base effects given that work sites were largely at a standstill between April to June last year.

In absolute terms, however, the sector’s growth was 25.1% below pre-Covid-19 levels. This is, as activity at construction worksites was weighed down by labour shortages.

Meanwhile, the information and communications, finance and insurance and professional services sectors collectively expanded by 7.7% y-o-y, continuing the 10.1% y-o-y growth seen in 2Q2021. While all segments saw expansions, professional services in particular saw a pick up in growth from the low base of 2020 during the circuit breaker period.

In the same vein, the manufacturing sector expanded by 7.5% y-o-y thanks to output expansions in all clusters except the chemicals cluster. The electronics and precision engineering clusters in particular, registered strong growth amid the sustained global demand for semiconductors and semiconductor equipment.

However, this growth pace is lower than 2Q2021’s 17.7%. DBS senior economist Irvin Seah warns that manufacturing momentum is waning. This sector, which has driven the economy earlier this year, is suffering from supply chain disruptions that have crimped sales.

Similarly, growth across clusters saw the wholesale and retail trade and transportation and storage sectors grow by 5% y-o-y. Wholesale trade, for one benefited from a pick- up in external demand while the expansion in the transport and storage sector was due to the low base of the year before.

Finally, the accommodation and food services, real estate, administrative and support services and other services sectors expanded 3.1% y-o-y, down sharply from 2Q2021’s 14.5% y-o-y growth. Within the group, the real estate and other services sectors as well as administrative and support services contracted due to the ongoing travel restrictions and tighter restrictions domestically.

‘Above trend’

Looking ahead the government is keeping its full-year 2021 GDP fore- cast of 6% to 7%. Growth momentum is seen to continue with an “above trend” growth pace for 2022. The authorities cite that labour conditions will continue to tighten and the negative output gap is expected to close in 2022. From a global economic lens, they note that growth will also come in above trend for the second consecutive year, in 2022.

Accordingly, Maybank Kim Eng economists Chua Hak Bin and Lee Ju Ye are maintaining their full-year growth forecast for 2021 and 2022 at 6.8% and 3.5%, respectively. “We expect domestic demand to continue improving in the fourth quarter, with the economic reopening and relaxation of border controls,” they say, adding that the tourism and air transport sectors will get relief from the addition of more countries that Singapore has a vaccinated travel lane agreement with.

OCBC’s Ling — who has also maintained her full-year growth estimate of 6.7% — believes that the nation’s output should return to full potential next year, barring a global resurgence of the virus or a setback in the pace of re-opening.

Meanwhile, DBS’s Seah has raised his 2021 forecast from 6.3% to 6.7%, as he is betting that the high level of vaccination will make for a safe re- opening of the economy and allow economic activities — including travel — to further resume.

“Progress in this regard has been encouraging. Barring the risks on the efficacy of existing vaccines being weakened as a result of virus mutations or waning antibody levels, the reopening of the economy is expected to provide renewed impetus to growth over the next 12 months,” says Seah.

Cover image: Bloomberg

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