Asia Economy

Singapore’s Central Bank Caught Between a Rock and a Hard Place

Dhara Ranasinghe|Senior Writer Asia-Pacific

Talk that Singapore’s monetary policy will be eased soon is growing louder as the economy teeters on the brink of recession. Yet, high inflation puts the country’s central bank in a bind and its next policy move is by no means a done deal, economists say.

Singapore paper currency and coins
Imagemore | Getty Images

The Monetary Authority of Singapore (MAS), the country’s central bank, is expected to unveil its half-yearly policy statement next week, possibly coinciding with the release of data showing how the economy performed in the third quarter.

The MAS sets monetary policy by allowing the Singapore dollar to rise or fall against an undisclosed basket of currencies. In its last policy statement in April, the MAS said it would allow a modest and gradual rise of its currency with a slightly steeper slope of appreciation to keep inflation in check.

So if it decides to ease monetary policy it would do so by slowing the rate of appreciation in the local currency , which was trading at 1.2335 to the U.S. dollar on Wednesday.

Judging by the latest data, Singapore’s economy, which shrank 0.7 percent in the second quarter from the previous one on an annualized seasonally adjusted basis, probably slipped into a recession with a further contraction in the third quarter, economists say. 

Singapore’s manufacturing sector contracted for a third straight month in September, a survey released late Tuesday showed. August factory output fell 2.2 percent from a year earlier, and non-oil domestic 10.6 percent from the year before, hurt by a fall of almost 29 percent in shipments to the European Union, Singapore’s largest market.

“Speculation that the MAS will ease monetary policy is definitely heating up as we head towards the next central bank meeting,” said Justin Harper, market strategist at IG Markets.

“But it will be a juggling act for the central bank because inflation has been stubborn and they may want to see inflation come down further before they ease,” he added.

Stubborn Inflation

Singapore’s consumer price index rose 3.9 percent in August from a year earlier, the lowest in almost two years. While moderating, than the central bank has anticipated because of lofty property and car prices.

The MAS said in July that full-year inflation was expected to stay in the upper half of its official forecast range of 3.5 to 4.5 percent.

Vishnu Varathan, an economist at Mizuho Corporate Bank in Singapore, says while he expects the MAS to ease monetary policy slightly because of the weak economic outlook, the inflation backdrop means the decision will be a close call.

“There is no easy policy response to the contradiction of fragile demand conditions and supply-side inflation risks,” Varathan said in a note on Wednesday.

“The inclination should still be dovish and so we hold on to our view that the Sing dollar slope could be reduced gently, but this is a very close call. Increasingly, there is a chance that the MAS could choose to leave its present monetary policy stance intact,” he said. 

For some analysts, easing inflation meant the MAS did have room for maneuver.

“With inflation now below 4 percent year-on-year, there is less reason for Singapore to keep the appreciation of its exchange rate at an accelerated pace,” said Manish Jaradi, senior investment strategist and DBS Bank in Singapore.

“We expect the monetary authority to flatten the (upward) slope of Singapore dollar nominal effective exchange rate band to 2 percent year from the current estimated 3 percent pace,” he said.

If the MAS loosens monetary policy next week it would join major central banks, including those in the U.S. Japan and Australia, which have all eased monetary policy in the past month to shore up their economies.

With China’s economy slowing, the debt crisis in Europeundermining demand for exports and U.S. growth still fragile, the outlook for the world economy remains weak.

“The problem is the weakness in the economy is mostly because of what is happening outside Singapore, so the MAS needs to be careful as they cannot control that,” said Harper at IG Markets. “I think it’s too soon for them to start tweaking policy just yet.”

- By CNBC's Dhara Ranasinghe