Based on current MAS policy, core inflation will fall to 2% by early 2025

Edward Robinson, chief economist at MAS, says the central bank's gradual tightening of monetary policy has led to a gradual decline in inflation.

According to Edward Robinson, Chief Economist of MAS, the current policy of the Monetary Authority of Singapore (MAS) will keep the nominal effective exchange rate of the Singapore dollar (S$NEER) at an appropriately restrictive level to ensure that core inflation falls to 2% by early 2025.

Speaking on inflation and monetary policy at the JP Morgan Asia Macro Conference on March 6, Robinson noted that the forecast was based on the absence of any significant external shocks – such as those causing current global inflation.

By using the exchange rate as a monetary policy tool, Singapore has been able to change domestic monetary conditions independently of other major central banks, which have reacted “seemingly sluggishly” to inflationary pressures created by the series of shocks to global demand, supply and international financial conditions that began with the Covid-19 pandemic in 2020.

He says that the MAS's gradual tightening of monetary policy has so far helped to curb the momentum of price increases and enable a gradual decline in inflation by taking advantage of the MAS's ability to change exchange rate expectations.

These efforts to restore price stability have led to a peak in core inflation, according to Robinson. MAS core inflation is expected to moderate further later this year, having reached 4.2% in 2023, slightly higher than 2022 (4.1%).

Global inflation surge

The forecast for Singapore is in line with global expectations that headline and core inflation will return to low levels. “We are not quite at inflation targets, but we are closer to them than many expected at this point, and we have done so without going through a protracted recession,” he says, attributing the progress to both luck and the work of central banks sticking to their inflation targets.

Robinson believes most central banks “missed” inflation and were slow to react, even as price increases began to pick up steam in 2021. They adopted a wait-and-see approach for nearly a year. Those that began taking action in mid-2021 did so slowly, he says.

“Perhaps the idea of ​​looking beyond temporary supply shocks has taken hold, but more likely the complexity of simultaneous demand and supply shifts has confused central banks and other observers,” he adds.

The story continues

However, Robinson acknowledges that it was difficult to predict the rise in consumer price inflation between late 2020 and mid-2021, long before the Russian invasion of Ukraine. This rise was largely due to three factors.

First, restoring global supply chains after the Covid-19 pandemic proved much more difficult than expected. Entire industries became vulnerable to delays in restarting factories and shipping. Central banks did not expect these disruptions to be so extensive or to last so long, he says.

Second, the pandemic has severely disrupted labor markets around the world and led to structural changes, making traditional indicators of tight or loose labor market conditions less reliable.

And finally, the strength of consumer demand in response to their improved financial position, partly due to government stimulus measures. When pandemic restrictions were in place, demand for goods was strong, but shifted toward services after restrictions were relaxed, Robinson says.

MAS policy stance

Against the backdrop of these macroeconomic developments, the MAS attempted to adapt its monetary policy stance in a timely manner to the changed situation and outlook of the global economy.

The MAS tightened its monetary policy five times in a row from October 2021 – “relatively early” in the inflation cycle, according to Robinson – before leaving its parameters unchanged in April 2023.

In its latest monetary policy statement (MPS) in January, the central bank maintained the prevailing rate of appreciation of its key S$NEER interest rate band, with no changes to the width of the band or the level at which it was centered, after the band had already remained unchanged in the previous MPS in October 2023.

Overall, the MAS tightened monetary policy in five consecutive steps from October 2021 to October 2022, including two unscheduled steps in January and July 2022 and three consecutive upward recentering of the policy rate band.

Explaining this policy framework, Robinson says that the MAS rolled back some policy easing in October 2021 and again in January 2022 in the wake of the steady economic recovery from the pandemic and the early rise in inflation.

“It was clear to us that the policy framework that had been in place during the worst of the COVID-19 crisis was no longer appropriate,” Robinson recalls. “We then took further tightening measures in the first half of 2022, motivated by the faster-than-expected acceleration in inflation in the wake of the Russia-Ukraine war.”

The economist points out that the main advantage of acting early and aggressively was that MAS was able to exploit the role of the exchange rate in filtering imported inflation. “Our econometric simulations show that imported inflation would have averaged almost 6% each year for the past two years, compared to about 2.5% under actual policy.”

Although the global and domestic growth outlook is deteriorating and becoming more uncertain in the second half of 2022, Robinson points out that MAS has maintained its course of tightening its monetary policy stance in the face of continued rising import prices and increasing domestic cost pressures.

Strong Singapore dollar is not a burden on growth

The significant appreciation of the Singapore dollar over the past two years has contributed significantly to bringing supply and demand in Singapore back into better balance through spending cuts and conversion effects.

However, the associated increase in the real effective exchange rate (S$REER) has raised some concerns about the impact on Singapore's export competitiveness.

“While Singapore's economy experienced a series of weak export performances from late 2022 into 2023, our empirical work suggests that these were mainly due to weak external demand rather than a loss of external competitiveness,” Robinson says.

He believes that a weaker Singapore dollar would not have provided much of an export boost given weak external demand, as the global electronics industry is set to enter a cyclical downturn in 2023 after a boom in 2022. “Overall, the downturn and recent recovery in Singapore's electronics exports have been broadly in line with other major electronics producers in the region.”

Robinson says that over the long term, the real exchange rate will reflect the strength and prospects of Singapore's economic fundamentals relative to those of its trading partners and competitors.

According to him, Singapore's economic competitiveness is determined by many factors other than the exchange rate or absolute cost comparisons. “The appreciation of the Singapore dollar is not necessarily an obstacle to investment or growth,” says Robinson. “The quality of our human capital, infrastructure, connectivity and institutions, as well as other factors, speak for themselves.”

He adds that Singapore's tradable sectors have been able to adapt to the higher costs through efficiency gains and by shifting to industries that can command higher premiums or better trading terms in global markets. “These factors continue to put Singapore well positioned to benefit from shifts in global manufacturing and trade as geopolitics evolve and supply chains are reconfigured.”

See also: