11 October 2004

INTRODUCTION

1   In April this year, MAS shifted from a zero percent appreciation path to a policy of modest and gradual appreciation of the S$NEER, against a more favourable growth outlook for the Singapore economy and the risk of rising inflationary pressures.  The width of the policy band was kept unchanged.  In the event, the economy grew strongly by 11.9% in Q2 2004 on a quarter-on-quarter seasonally adjusted annualised basis, while CPI inflation increased to 1.9% from 1.4% in Q1.  The labour market also strengthened with some 10,900 jobs created in Q2.

Chart 1
Nominal Effective Exchange Rate (S$NEER)

2   At the time of the release of the Monetary Policy Statement (MPS) in April, the S$NEER had appreciated to the upper end of the policy band.  Following the announcement, the S$NEER trended downwards, largely reflecting a general strengthening of the US dollar against major currencies and concerns over the implications for the region of a marked slowdown in the Chinese economy.  Since mid-August, the S$NEER has reverted to an appreciating trend, reflecting a general weakening of the US dollar and stronger capital inflows to the region with greater optimism over the regional outlook.  (Chart 1)

3   Monetary conditions have generally tightened since mid-2004.  Domestic inter-bank rates have risen in tandem with the 75 basis point increase in the US federal funds rate since June.  Having remained unchanged at 0.75% over the first five months of this year, the three-month domestic interbank rate rose to 0.81% by end-June, and further to 1.44% by end-September.  However, reflecting the ample liquidity in the banking system, retail interest rates have thus far remained unchanged.  Meanwhile, lending activities in the domestic banking sector have continued to improve gradually, supported by an increase in housing loans, and to a lesser extent, credit extended to the corporate sector, as business prospects improved.

OUTLOOK FOR 2004 and 2005

4   The Advance GDP Estimates for Q3 2004 released by the Ministry of Trade and Industry (MTI) show real GDP contracted by 2.3% on a quarter-on-quarter (QOQ) seasonally adjusted annualised basis, following four quarters of unprecedented strength in growth momentum. The slippage in QOQ growth reflected in part the decline in biomedical output due to changes in the production mix.   On a year-on-year basis, the economy expanded by 7.7% in the third quarter, bringing growth in the first three quarters of the year to a strong 9.2% compared to the same period last year.

5   With economic activity having reached a relatively high level, the Singapore economy is expected to grow at a more moderate pace going forward.  For 2004 as a whole, GDP growth is forecast to come in between 8-9%, and for 2005, between 3-5%, in line with the economy's medium-term growth potential.  The forecast for 2005 is predicated on some slowdown in global IT demand and weaker growth in the external economies.

6   Consumer prices have been on the rise since June 2003, alongside the strong economic recovery and higher commodity prices, especially oil.  CPI inflation averaged 1.6% in the first eight months of this year, and is expected to come in at between 1.5-2.0% for the year as a whole.  Notwithstanding the slower growth, domestic price pressures are expected to persist, as the economy continues to expand and the labour market improves.  In addition, there is an upside risk to external inflationary pressures from stronger commodity prices in particular, as well as the potential for a higher degree of pass-through of these cost increases in a strengthening domestic economy.  On balance, CPI inflation for 2005 is expected to come in between 1-2%.

MONETARY POLICY

7   Going forward, the domestic economy will be entering a period of more moderate and sustainable pace of expansion.  CPI inflation will remain largely contained for 2005 as a whole, although some upward pressures on consumer prices are expected.  Against this backdrop, MAS will be maintaining its policy of a modest and gradual appreciation of the S$NEER.  There will be no change in the slope or the width of the policy band.  This policy stance will remain supportive of economic growth, while ensuring low and stable inflation over the medium term.

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Related:

Past Monetary Policy Decisions