MAS not expected to intervene given benign inflation forecasts

More than a year has passed since the onset of the Covid-19 pandemic. While we are now more optimistic that better days are ahead, the fight is not yet over.

Much more needs to go right for us to be sure that we are entering the final stage of the battle to beat Covid-19.

Traditionally, as we move into the recovery and growth phase of an economic cycle, we can expect to see an uptick in inflation from increased consumption of goods and services amid a tighter labour market.

We are certainly seeing the positive signs of recovery. The International Monetary Fund has upgraded its 2021 global economic growth outlook to 5.5 per cent.

UOB Global Economics and Markets Research has also pencilled in a gross domestic product expansion projection of 5.5 per cent for Singapore this year on the back of better-than-expected performance in the first quarter. As economic conditions improve, the country’s labour market is likely to tighten.

We expect job numbers to improve and the unemployment rate to fall to 2.6 per cent in the fourth quarter of this year, down from 3 per cent in the same period a year ago.

Should we expect the bounce back from Covid-19 to follow previous cycles or are there signs that this recovery will be a little different? Will rising inflation erode household purchasing power? What levers will the Monetary Authority of Singapore (MAS) use as we continue on the road to recovery?

There is little doubt that the nation remains vulnerable to imported inflation as it relies on overseas supplies for necessities, such as food, energy and raw materials. Higher commodity costs, especially in base metals and energy, contribute to elevated import prices and affect inflation.

Global supply chain disruptions also play a part. An event in the Suez Canal, for instance, can cause ripple effects that may reach our shores.

Aside from global drivers, domestically-driven inflationary pressures, including policies introduced in Budget 2021, may also play a part in determining consumer prices this year. For example, policies supporting domestic wages or leading to increased input costs (such as the eventual reduction of the S-Pass sub-dependency ratio ceiling in the manufacturing sector next year and in 2023) may spill over to consumer prices.

Similarly, the rise in petrol duties may also have an impact on Singapore’s transport-reliant industries, such as food, private road transport and recreation and culture. Such changes could affect the consumer wallet in different ways, such as when they grab a ride to work or take their family out for a meal or outing.

Notwithstanding the inflationary cues seen at this juncture, we expect no change in monetary policy action this month, given three key factors:

Inflation risks remain benign in 2021

We expect inflationary risks to be kept at bay with Singapore’s headline and core consumer price indices both expected to average 1 per cent this year.

Despite the extension of wage support and ongoing discussion of wage increment subsidies, there is still a long way to go for wage growth to spur higher domestic consumption to the extent of lifting inflation.

This is on the back of a soft labour market seen last year, where the average unemployment rate was 3 per cent, against the pre-Covid-19, 20-year average rate of 2.5 per cent between 2000 and 2019. The job vacancy to unemployed person ratio was at 0.77 in the fourth quarter of last year, suggesting that there are still more unemployed people than work opportunities.

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Meanwhile, disinflationary pressures may continue to persist as the policies aimed at wage enhancements benefit only a small percentage of the workforce.

Despite Singapore’s vulnerability to imported inflation, consumer prices may stay benign in the year ahead. The central bank, through its monetary policy framework, has upheld price stability as its overriding objective.

As a result, a slower pace of increase in consumer prices in the country has largely been observed as compared with the seven major Organisation for Economic Cooperation and Development countries and the rest of the world since 1981.

As such, we do not foresee prices to rise in the near term. This can be due to policy-induced factors, as well as the current relatively weaker labour market compared with pre-Covid-19 levels.

A vaccine-driven recovery remains to be seen

As the global economy recovers, we will continue to face economic uncertainties on the back of Covid-19-related risks.

For example, there has been a resurgence of infections in many parts of the world. In Europe, Spain and Italy re-entered lockdowns again in the second week of last month.

Closer to home, India and the Philippines are also facing a spike in infection rates.

Vaccine concerns aside, an uneven recovery is still expected across Singapore’s key sectors. The impact of Covid-19 on tourism demand will likely cap growth in service-oriented industries such as retail trade, aviation and transport.

While the country has largely kept the virus under control, its economic growth is still reliant on the recovery of the global economy and a return to a pre-pandemic environment is still not yet within reach.

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Still room for a weakening Singapore dollar without further policy action

The Singapore dollar nominal effective exchange rate has been hovering around its midpoint since the last policy decision by the MAS last October.

As such, the currency basket may move either way in response to the evolving economic environment and this leaves room for the Singapore dollar to weaken if needed, without a loosening of monetary policy at this point.

In a nutshell, we expect the MAS to keep policy parameters unchanged this month as it may be too early for it to tighten monetary policy at this stage of economic recovery.

Nonetheless, we expect policymakers to highlight the risks of higher import prices and stronger inflationary pressures in the second half of this year.

A stronger Singapore dollar may be on the cards to uphold domestic price stability and the good news is that Singaporeans may enjoy stronger purchasing power when they shop online for overseas goods or when the time comes for them to return to travelling overseas.

• The writer is an economist at UOB.

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