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MAS tightens monetary policy again: What it means for inflation, interest rates and the Sing dollar

Will the latest tightening move by the Monetary Authority of Singapore bring down inflation soon? And what's the outlook for the Singapore dollar? We ask the economists.

MAS tightens monetary policy again: What it means for inflation, interest rates and the Sing dollar

People wearing protective face masks at a traffic crossing across Ang Mo Kio MRT in Singapore on Mar 29, 2022. (Photo: CNA/Marcus Mark Ramos)

SINGAPORE: Not letting up the fight against inflation, Singapore’s central bank on Friday (Oct 14) tightened monetary policy for the fifth time in 12 months.

The Monetary Authority of Singapore (MAS) said at a scheduled policy meeting that it will re-centre the mid-point of the Singapore dollar nominal effective exchange rate (S$NEER) policy band “up to its prevailing level”.

The slope and width of the band – two other levers in the MAS’ policy toolkit – were left unchanged.

Unlike most central banks that manage monetary policy through the interest rate, MAS uses the exchange rate as its main policy tool. 

It lets the exchange rate float within an unspecified policy band, and changes the slope, width and centre of that band when it wants to adjust the pace of appreciation or depreciation of the Singapore dollar.

In general, by tightening monetary policy, MAS is effectively allowing the Sing dollar to appreciate. This makes imports cheaper and in turn, helps to put a lid on the rise in prices of goods and services here.

How Singapore’s monetary policy works

A primary objective of the MAS is to ensure price stability as a basis for sustained growth of the Singapore economy.

Price stability, according to the central bank, is a situation in which broad-based inflation is contained, and is not a significant consideration for households and businesses when they make consumption and investment decisions.

The MAS uses the exchange rate as its main policy tool because Singapore is a small and open economy that depends heavily on trade. The exchange rate also has “a much stronger influence” on inflation than the interest rate, it said on its website.

Its monetary policy framework is centred on managing the Singapore dollar against a trade-weighted basket of currencies, known as the Singapore dollar nominal effective exchange rate (S$NEER).

MAS allows the S$NEER to float within an unspecified band. Should it go out of this band, it steps in by buying or selling Singapore dollars.

The central bank also changes the slope, width and mid-point of the band when it wants to adjust the pace of appreciation or depreciation of the local currency based on assessed risks to Singapore’s growth and inflation.

Shifting the slope of the policy band is probably the most common tool used by the MAS.

Simply put, the slope determines the rate at which the Sing dollar appreciates. If the slope is reduced, this means the local currency will be allowed to strengthen at a slower pace. It strengthens at a faster pace when the slope is increased.

Occasionally, the MAS would also adjust the level of the mid-point or the width of the band. 

The former is a tool generally reserved for “drastic” situations, such as recessions, when the outlook for growth and inflation sees an abrupt and rapid change. Compared to tweaks in the slope, an adjustment in the mid-point either upwards or downwards is likely to yield a quicker and bigger impact on the currency.

Meanwhile, the width of the policy band controls how far the Sing dollar can fluctuate. This means the wider the band, the more volatile the currency can be. It is typically reserved for periods of increased uncertainties or volatility.

For instance, the band was widened in October 2001 after the Sep 11 terrorist attacks in the United States led to extreme volatility in the financial markets. More recently in October 2010, the width was also widened slightly “in view of the volatility across international financial markets”.

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Friday’s policy decision marks the third consecutive re-centring move by the MAS – a tool generally reserved for “drastic” situations such as recessions, when the outlook for growth and inflation sees an abrupt and rapid change.

Economists were expecting a more aggressive “double-barrelled” tightening move, in which the policy band will see its mid-point re-centred higher and its slope steepened.

“I had expected a more aggressive stance from the MAS today due to inflation and the outlook for price pressures,” said ING’s senior economist Nicholas Mapa.

“The only reason that could have stayed the MAS’s hand from doing more would be expectations of slower growth, thus the decision to do only the upward adjustment in the midpoint.”

Echoing that, RHB’s senior economist Barnabas Gan said the latest policy statement had a “markedly more bearish” tone compared to the central bank’s off-cycle policy statement in July, suggesting that policymakers are increasingly worried about growth uncertainties in 2023.

Yet, with inflation remaining on an uptrend, MAS needed a “more effective” way to give the Sing dollar a jolt, said MUFG Bank’s senior currency analyst Jeff Ng.

In this case - a re-centring of the band’s mid-point, versus a steepening in the slope of the policy band which allows for a more gradual appreciation of the currency.

“The effects of policy adjustments generally take time to filter down (to the real economy) so to re-centre the mid-point, which immediately resets the S$NEER, will provide a faster response at this stage and curb some of the policy lag time,” Mr Ng said.

Mr Mapa said: “Given how aggressive the MAS has been in tightening, we do expect the impact to be felt over the next few quarters with the MAS indicating that the string of recent moves should dampen inflation ‘in the near term and ensure medium-term price stability’.”

TIGHTENING MAY NOT BE OVER AMID ELEVATED INFLATION

But the fight against rising prices – caused by a confluence of external and domestic factors such as supply disruptions pushing up imported food costs, higher energy prices and a tight labour market – is not over, as seen from the latest adjustments in the central bank’s inflation forecasts.

The MAS said on Friday that it now expects full-year core inflation for 2022 to average around 4 per cent, while headline inflation is projected to be around 6 per cent.

These are at the upper end of its earlier estimates, which predicted core inflation to be between 3 to 4 per cent and headline inflation to be at 5 to 6 per cent.

Moving into next year, core inflation is seen at 3.5 to 4.5 per cent and headline inflation is estimated to be at 5.5 to 6.5 per cent, after taking into account the impact of the scheduled Goods and Services Tax (GST) hike.

The central bank warned of “upside risks” to these forecasts, including fresh shocks to global commodity prices and second-round effects associated with a prolonged period of high inflation.

In addition, the central bank said it expects core inflation to “remain high” in the first half of 2023 before a slowdown in the later part of the year

This, said OCBC’s chief economist Selena Ling, is “a far cry” from earlier expectations that inflationary pressures would peak in the second half of this year and stabilise.

With that, economists said the MAS has left the door open to further tightening.

Ms Ling, who is also the bank’s head of treasury research and strategy, said MAS’ decision on Friday to “not do a slope steepening could be interpreted as reserving some ammunition on the table” for its next scheduled meeting in April.

Agreeing, Mr Gan said: “With inflation likely to stay elevated in the quarters ahead, we do not discount another possible policy tightening in April 2023.”

Barclays Bank’s senior regional economist Brian Tan said while he does not expect the MAS to further tighten monetary policy next year, the risk of doing so “remains significant if inflation expectations rise further” due to the GST hike.

OUTLOOK FOR SING DOLLAR AND LOCAL INTEREST RATES

With the MAS’ latest move, the Sing dollar is set to remain one of the top-performing currencies in the region.

So far this year, the local currency has strengthened and hit record levels against several of its regional peers, including the Malaysian ringgit, Japanese yen and the Korean won.

But against the US dollar, which has been on a turbo-charged rally as the US Federal Reserve stays on an aggressive rate-hike trajectory, the local currency will remain on the back foot, analysts said.

Year to date, the Sing dollar has depreciated about 5 per cent against the greenback. As a knee-jerk reaction to the MAS decision on Friday morning, the Sing dollar rose about 0.6 per cent to 1.4213.

Mr Ng expects the Sing dollar to hit 1.4550 against the US dollar by the year-end due to “overwhelming dollar strength”.

“We revise our USD/SGD forecasts slightly lower in the light of recent developments, but still see US dollar strength threatening expected gains in the S$NEER,” he said.

Likewise, the MAS’ policy tightening moves will help to moderate the increases in local interest rates, albeit only “slightly”, said Mr Ng.

With the use of an exchange-rate policy and an open capital market, Singapore’s interest rates are largely determined by global interest rates, especially that in the US which is the world’s biggest economy. 

With that, benchmark interest rates in Singapore are set to go up further, meaning even more pain for borrowers.

Already, banks have been making swift adjustments to their mortgage rates. Earlier this month, the three local lenders – DBS, OCBC and UOB – raised their fixed rate home loans to as high as 3.85 per cent.

Mr Ng sees the three-month compounded Singapore overnight rate average (SORA) – used by banks to price floating home loans – hitting 3.5 per cent by the year-end. This benchmark rate has gone up rapidly from 0.1949 in January to 2.2353 as at Oct 14.

Ms Ling agreed: “While the stronger S$NEER policy could theoretically dampen the pass-through from higher USD interest rates to SGD interest rates, nevertheless SGD rates may track USD rates more closely from here.”

Source: CNA/sk(gs)

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