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Oil price crash brings out Singapore dollar bears

Ian Waldie | Bloomberg | Getty Images

Bearish forecasts for the Singapore dollar are growing amid expectations that crude oil's recent tumble will result in looser monetary policy.

The Singapore dollar dropped more than 7 percent against the U.S. dollar over the past six months as the Federal Reserve brought its asset purchase program to an end and appears on course for further weakness given lower oil prices. Deutsche Bank believes it could weaken to S$1.40 this year, a level not seen since July 2010, while Standard Chartered expects it to hit S$1.37; the USD/SGD is currently trading at S$1.33.

Declining inflation will lend a dovish tilt to the central bank's policy bias this year amid cheaper oil prices, underpinning currency weakness, Deutsche Bank said in a recent report.

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"Given the 50 percent annual plunge in oil, core inflation should fall to under 1 percent on year by April. This we believe will open up room for the Monetary Authority of Singapore (MAS) to ease policy," it said, referring to the country's central bank.

Energy and food items combined have a weighting of 27 percent in Singapore's consumer price inflation basket. Brent crude prices have plunged more than 50 percent since August, trading around $50 presently and major banks including Goldman Sachs expect the commodity to close out the year at that level.

Monetary policy in the Southeast Asian city state is based on a trade-weighted exchange rate that comprises a basket of currencies, called the Singapore Dollar Nominal Effective Exchange Rate (SGD NEER). Meanwhile, core inflation, a measure that excludes the price of accommodation and private road transport, is the main target variable for monetary policy and is expected to average between 2-3 percent this year, according to official forecasts.

"Singapore is one of the few countries that include energy prices in her measure of core inflation, given reliance on imported energy and the direct impact of foreign exchange policy on imported prices. The dramatic decline in oil prices should therefore be considered an important input to policy here," Deutsche Bank said.

Economists at Goldman Sachs recently revised down their 2015 consumer price inflation forecast to 0.9 percent from 1.5 percent on the back of oil's slide.

A two-step approach

Deutsche Bank believes MAS easing will occur in a two-stage process: first, it will allow the SGD NEER band to break the middle band of 0.5 percent, after which the bank will lower the policy slope from 2 percent per annum presently to 1 percent at its next meeting in April.

The middle band has acted as a floor for the SGD NEER over the past two years. Anytime the Singapore dollar comes close to testing that level, officials typically resort to a drawdown of reserves to defend the currency.

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"In recent weeks however, SGD NEER has broken this level, and is now trading 40 basis points below the middle band on our model. In our view, this break acts as a signal that MAS could entertain easing in the future," Deutsche Bank said.

Last week, Standard Chartered noted that the SGD NEER traded 0.6 percent into the weaker half of the policy band, and said it had potential to drop further.

Not so fast

Calls for looser policy remain contrarian among the majority of analysts who say it's unlikely to happen anytime soon.

"Even with core inflation below official targets, there's no way we see MAS easing policy. Core inflation would have fall close to zero or even below that for the MAS to act. 1 or 1.5 percent is not a significant enough level," Nizam Idris, head of strategy, fixed income and currencies at Macquarie, said over the phone. He expects the currency to resume its upward trend towards the second half of the year, with a year-end target of S$1.35.

Maybank shared that view, noting that hurdles for a monetary policy change remains high. In a report last month, it said the risks were finely balanced between growth and inflation, which should see MAS likely maintain its historical policy of "modest and gradual" appreciation of the SGD NEER.