QE3 may add twist to inflation-growth balance

External pressures: Oil is of particular concern in the geopolitics inflation wildcard - PHOTO: BLOOMBERG
[SINGAPORE] What has for months been deemed a delicate balancing act for Singapore's central bank - tasked with ensuring "non-inflationary economic growth" - could turn more challenging yet.

Even as last month's double-digit drop in exports underscored Singapore's deteriorating growth, there are still risks that inflation may not be as reined in as expected.

Add to that the prospect of capital inflows sparked by the US Federal Reserve's open-ended third round of bond-buying last week, and it will become clear that policy-making has become decidedly more complex.

While prices of commodities such as oil and copper eased slightly yesterday after surging on news of the QE3, concern about external price pressures from other sources remains.

Oil is of particular concern, as anti-Western protests heightened tensions in the Middle East over the past few days, raising the risk of a supply disruption.

Already, US sanctions against Iran and an EU embargo this year have sharply reduced Iranian exports of crude oil.

OCBC economist Selena Ling, who sees geopolitics as the key inflation "wildcard" for now, said: "If global commodity prices continue to edge higher, particularly those for crude oil, then we could see the spillover effects into headline consumer price index (CPI) by early 2013."

With less than a month till the central bank's twice-yearly policy review, most economists are sticking to the view that the MAS will move to allow the Singapore dollar nominal effective exchange rate to rise at a slower pace and help export competitiveness against a worsening growth backdrop.

But MAS could also be prompted to keep its current stance of "slightly steeper" appreciation instead, said Citi economists Kit Wei Zheng and Brian Tan.

They said in a note that this is especially if it sees the need to anchor inflation expectations and takes into account the impact of QE3 on capital inflows and imported inflation on effective policy implementation.

Although they still expect a "calibrated easing" from the central bank next month, Citi's economists say the odds may have waned a little.

By their estimates, the SGD NEER is now at the top side of the band within which MAS manages the exchange rate. What this means is that if MAS eases next month amid a tide of capital inflows, it may have to intervene more in the foreign exchange markets to keep SGD NEER within the band.

But this could in turn "raise the risk of loosening liquidity and exacerbating asset price risks further", Citi economist Johanna Chua said.

RBS economist Enrico Tanuwidjaja is one who thinks MAS should not ease but keep to its current stance. He believes Singapore's inflation remains domestically driven and is not effectively tackled with exchange rate policy.

"I reckon the government has some room to take more macroprudential action," he said.

Easing monetary policy now risks pushing wage growth higher too, given current labour market tightness, which could have a knock-on effect on inflation. He estimates that for every percentage increase in workers' average earnings, core inflation rises by 0.3 percentage point.

However, other economists say that despite an uptick in nominal wage growth from Q1 to Q2, at 2.8 per cent, it is still significantly under the peak of 8.5 per cent in Q1 last year.

Credit Suisse economist Michael Wan, who does not think domestic price pressures have changed much following QE3, said: "Slower nominal wage growth should temper the business cost pass-through onto consumer prices."

He expects the two components which have kept inflation up - housing and cars - to continue to dominate for the rest of this year. "The market's renewed optimism hasn't changed the fundmental fact that economies in the region and the world remain weak. That in itself should prove the biggest drag on headline and core inflation for this year and next," he added.

Where the market's optimism could have an impact is on car prices - already elevated due to the cut in certificate of entitlement quotas. "The STI is now trading close to its year-to-date highs, and perceived wealth effects could filter down to the COEs at some stage," Ms Ling said.

Mizuho Corporate Bank economist Vishnu Varathan pointed out, however, that QE3's inflationary impact has been near-term and indirect, and unlikely to cause a "step-up" in inflation that would be a persistent problem for the central bank.

One mitigating factor has been the strengthening of the Singapore dollar against the US dollar, even as prices of largely dollar-denominated commodities surged after QE3.

And while it is inevitable that additional liquidity will find its way to Asia and could push property prices up, this may not translate directly into higher accommodation costs as they are calculated in the CPI - using imputed rents.

Waning actual demand could mean lower rental yields despite higher property prices, Mr Varathan said.