MAS Signals It Will Allow Stronger Sing Dollar To Fight Inflation

Source : The Business Times, April 11, 2008

Strong Q1 GDP numbers seen giving MAS more room to tackle price rises

The Monetary Authority of Singapore (MAS) yesterday effectively gave a one-time boost to the Singapore dollar to fight inflation, surprising analysts who had expected the central bank to leave its stance on the currency unchanged.

The MAS said that it would re-centre its undisclosed policy band for the trade-weighted Sing dollar, or S$NEER, at the prevailing level of the S$NEER - widely believed to be near the top of the previous tolerated range - while leaving the slope and width of the band unchanged.

The shift would help to moderate inflation ‘while providing support for sustainable growth in the economy’, the MAS said in its closely watched twice-yearly monetary policy statement.

Currency strategists suggested that the government’s better-than-expected advance estimate of 7.2 per cent gross domestic product growth in the first quarter - also released yesterday - had temporarily relieved fears that a stronger currency would stifle economic growth and gave the MAS room to tackle rising inflation by nudging the Sing dollar higher.

Unlike the US Federal Reserve, which sets interest rate targets, the MAS implements its monetary policy by steering the exchange rate of the Sing dollar against the currencies of Singapore’s major trading partners.

Raising the policy band by setting its new mid-point at the prevailing level of the S$NEER is more abrupt than making the slope of the band steeper - as the MAS did last October - which would encourage a faster but gradual pace of currency appreciation.

The last time the central bank re-centred the policy band without changing its slope was in July 2003. In April 2004, it shifted from a neutral policy stance to the ‘gradual and modest’ appreciation stance that it has used since.

Analysts suggested that the MAS’s latest move - besides mitigating current inflation by lowering the price of imports - is also intended to arrest expectations of future inflation. If such expectations become entrenched, they could fuel a vicious cycle of wage and price increases that could spin out of control.

‘Immediate Sing dollar strengthening is the only possible intention,’ said HSBC economist Robert Prior-Wandesforde. The move ‘will serve to reinforce the bank’s anti-inflationary credibility’, he added.

Analysts at Goldman Sachs, HSBC and Standard Chartered Bank estimate that the move has lifted the policy band for the S$NEER by 1.5 per cent, consistent with an exchange rate of about S$1.35 to the US dollar.

But rising prices will remain a worry despite a stronger Sing dollar, which will not ease inflation pressure from domestic sources such as higher housing costs, analysts said. Most expect the S$NEER to trade near the top of the new policy band until the MAS issues its next monetary policy statement in October.

The MAS expects inflation this year - as measured by the consumer price index - to be in the upper half of its 4.5-5.5 per cent forecast range. But OCBC Bank analysts expect inflation to reach 6 per cent.

‘Given fresh record highs in many commodity prices, especially with food inflation which will hit developing countries more than the developed countries, we see little near-term relief on inflation,’ said OCBC analysts Selena Ling and Emmanuel Ng in a report.

Yesterday, the Sing dollar strengthened 1.8 per cent to a high of S$1.3567 in afternoon trading, before easing slightly to S$1.3572 at 7pm, according to Bloomberg data. Since the MAS’s statement on Oct 10, the Sing dollar has gained 7.4 per cent.

Goldman’s revised one-year forecast for the Sing dollar/US dollar exchange rate is S$1.32, while OCBC and Stanchart are forecasting an exchange rate of S$1.325 and S$1.35 at this year-end.