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Why the Singapore dollar rally may sputter out

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The Singapore dollar's surge to a nearly nine-month high may have caught analysts by surprise after weak economic data, but the rally is likely to be cut short soon, analysts said.

"The Singapore dollar is overvalued," said Callum Henderson, global head of FX research at Standard Chartered, with the gains driven by external factors, not domestic fundamentals.

The currency rallied 0.5 percent over the past week, with the greenback fetching just 1.2359 Singapore dollars Thursday, a level not seen since the end of October last year. It is up nearly 2 percent against the dollar year-to-date.

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Henderson expects the U.S. dollar will be fetching 1.26-1.27 Singapore dollars within the next three to six months, as weak economic data in the city-state starts to come back into play.

"What we've seen is reaction in U.S. dollar-Singapore dollar to general weakness that we've seen in the dollar against Asia," said Henderson.

In addition, "a lot of funds have been long the high yielders and short Singapore dollar," added Henderson. "Some of those hedges have been taken off, and to do that you've got to sell the whole thing."

A weaker-than-expected flash estimate for second-quarter growth led many analysts to downgrade their forecast for the economy's full-year growth. Data released Wednesday showed the island-nation's consumer price index rose 1.8 percent in June from a year earlier, down from May's 2.7 percent, as car prices rose at a slower pace, suggesting monetary policy isn't likely to be tightened anytime soon.

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"It seems from the change in macro rationale in the last few weeks [that] the justification for this move has weakened a little bit - [the move higher] doesn't really make sense," said Craig Chan, head of FX strategy for Asia ex-Japan at Nomura.

"It could also be related to political noise in Indonesia. People generally see Singapore as a safe haven, especially those in Indonesia and Malaysia," he added.

Indonesia faces some political uncertainty as the losing candidate in the presidential election, Prabowo Subianto, said he would challenge in the Constitutional Court the election commission's declaration of Jokowi Widodo as the winner, alleging widespread cheating.

Other analysts also told CNBC they weren't convinced of the staying power of the recent rally in the Singapore dollar, also known as the Sing.

"The rally has all been down to flows. Fundamentally there hasn't been a big driver for the Singapore dollar to strengthen," said Nizam Idris, head of strategy for fixed income at Macquarie.

Read MoreSingapore economy contracts in second quarter

According to Idris, currencies that have proven laggards in recent months - such as the Singapore dollar, the Thai baht and the Philippine peso -- have started to see inflows again recently as investors become more reassured that U.S. interest rates will stay lower for longer and the Chinese economy shows signs of stabilization.

Higher rates in the U.S. will likely push the U.S. dollar higher, weakening currencies traded against it.

"I don't see the Singapore dollar massively outperforming because fundamentals aren't particularly great. Singapore has the slight advantage of having reforms in the pipeline. That could be a long-term positive, but in the short term, we could be in for some pain," said Idris.

Read MoreSingapore dollar: the next currency to fall?

Singapore has embarked on labor reform targeted at boosting productivity. According to Idris, this will benefit the economy and the currency over the longer term, but could mean a tight labor market, pressure on wages to rise and potentially slower growth in the short term.

The Singapore dollar is partially controlled by the Monetary Authority of Singapore, which allow it to float within an undisclosed bandwidth against a concealed basket of currencies of Singapore's major trading partners and competitors.

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