Rising risks of early MAS tightening in October as economy recovers

Some economists see more pipeline pressures and risks of pass-through to consumer prices, but others see normalisation to begin only next April

Sep 27, 2021

SINGAPORE'S central bank is not widely expected to tighten its monetary policy next month, but the chances of an earlier policy normalisation are said to be rising.

The worsening Covid-19 pandemic had in March last year led the Monetary Authority of Singapore (MAS) to announce a "double-tap easing" - tweaking both the slope and the mid-point of the Singapore dollar nominal effective exchange rate (S$NEER) policy band.

Consensus is for normalisation to begin only in April next year. But economists also said the ongoing domestic and global economic recovery, as well as a pick-up in inflation, have raised the chances that tightening could come sooner than that.

MAS regulates the slope, width and mid-point of the S$NEER policy band to manage the strength of the Singapore dollar (SGD) against foreign currencies.

The slope of the S$NEER has been flat since the second quarter of 2020, in a policy decision that also saw MAS lower the centre of the band.

Singapore last had a zero-slope policy from April 2016 to April 2018, and some economic watchers now think the central bank could make a move to end the ongoing zero-slope stance as early as October.

"The global recovery is intact" and "an upgrade in the core inflation forecast cannot be dismissed", Philip Wee, senior currency economist at DBS, told The Business Times. He expects "a mild steepening in the slope of the policy band" in October.

JP Morgan analysts, meanwhile, suggested in a note issued early September that MAS may not only increase the S$NEER policy slope, but also shift the band mid-point.

Analysts Ong Sin Beng and Arthur Luk noted "a palpable shift in external price pressures" that will keep core inflation climbing.

Singapore's core inflation most recently came in at a higher-than-expected 1.1 per cent in August, up from 1 per cent in the month before, although the MAS maintained its forecast for full-year core inflation to average between zero and 1 per cent.

"With global price pressures rising, especially in a small, open economy that is a global price taker, monetary policy should respond in a calibrated and pre-emptive manner to corral price-setting behaviour early in the cycle," Mr Ong and Mr Luk said.

"Thus, given building pipeline pressures and rising risks of pass-through to consumer prices, it strikes us that an earlier move would be appropriate rather than waiting another half-year to the April meeting."

But BofA economist Mohamed Faiz Nagutha is sceptical of an early tightening in October. Indeed, much of the market still believes that the time is not right - especially as a spike in Covid-19 cases looms over the vaccination-enabled reopening.

"Notwithstanding the rosier economic outlook since the start of the year, we believe that Covid-19 risks may keep Singapore's policymakers cautious," UOB economist Barnabas Gan wrote in a note, while noting that headline inflation remains "benign".

With the S$NEER now trading around the mid-point of its band, there is also "ample room for the currency basket to go either way" outside of a policy intervention, he added.

Barclays analysts Brian Tan and Ashish Agrawal also said it is doubtful that the MAS would approve a tightening "while the risk of a sharp reversal in economic prospects - which could result in such tighter policy becoming insufficiently accommodative - remains material".

While Barclays said there is a risk of a "pre-emptive 100-basis point increase in the slope", a substantial move to shift the S$NEER band mid-point upwards is unlikely without a surge in economic activity or price pressures.

Meanwhile, Citi economists Kit Wei Zheng and Ang Kai Wei have estimated a two in five chance of a steeper S$NEER policy slope. They also expect the size of the adjustment to be smaller - at 50 basis points - "as insurance against upside inflation risks".

Factors that could drive tightening in October include an earlier-than-expected Goods and Services Tax hike and persistent supply constraints from global port logjams, they said.

Rather than an early tightening, analysts at Nomura said, MAS could use its upcoming half-yearly meeting to start "laying the foundation for April 2022".

BofA expects the MAS to jettison references to "an accommodative policy stance", which have been in its policy statements over the past year.

"This two-step process to the start of policy normalisation is similar to what happened prior to the 2018 tightening cycle, when forward guidance on the appropriateness of the 'neutral policy stance' was first removed in October 2017 before the policy slope was adjusted… in April 2018," Mr Nagutha added in an e-mail to BT.

In the lead up to any tightening, however, the SGD is expected to strengthen.

The Barclays team believes the S$NEER will make gains in the run-up to the October decision, but "a durable rally in the S$NEER is likely to only begin from late Q1 2022".

And, though the S$NEER could dip by up to 10 basis points in the immediate wake of a neutral stance being announced, it could bounce back to gain some 20 basis points within the day, the Nomura analysts have projected. In the event of a freak tightening, the S$NEER might rise even higher, by up to 60 basis points after 24 hours, they added.

Bank of Singapore currency strategist Sim Moh Siong estimated the SGD could strengthen to 1.31 against the US dollar (USD) by early 2022, though gains will be capped by a mixed USD outlook and rising hawkishness at the US Federal Reserve.