1 In April this year, MAS re-centred the exchange rate policy band at the prevailing level of the S$NEER, and shifted the policy band from that of a zero percent appreciation path to one of modest and gradual appreciation. This policy decision took into account the strong rebound of the Singapore economy from the downturn and incipient inflationary pressures emanating from domestic and external sources.
2 Since then, the S$NEER (Chart 1) has fluctuated in the upper half of the policy band, reflecting investors’ assessment of the more favourable growth outlook for Asia compared to the weaker prospects of the advanced economies. Against conditions of abundant liquidity globally, the domestic three-month interbank rate has eased further to 0.50% as at end-September this year.
OUTLOOK FOR 2010 AND 2011
3 Following the exceptionally strong pace of expansion in the first half of this year, the Singapore economy contracted by 19.8% on a quarter-on-quarter seasonally adjusted annualised basis in Q3 2010, according to the Advance Estimates released by the Ministry of Trade and Industry today. This reflected a sharp pullback in pharmaceutical output and some moderation in the underlying growth momentum in the rest of the economy, particularly in the trade-related industries.These include manufacturing (excluding pharmaceuticals), wholesale trade and transport & storage services. The downshift in economic growth in the second half of the year was largely expected as the temporary boost from inventory restocking waned and some pharmaceutical plants switched to the production of a different value-mix of active ingredients. Notwithstanding the sequential contraction in Q3, the economy recorded growth of 15.5% year-on-year in the first three quarters of this year. For 2010 as a whole, GDP is on track to grow by 13% to 15%.
4 Looking ahead, economic activity in the major industrial economies is likely to expand at a slower pace, following a fairly brisk recovery from the recession. Unemployment remains elevated and credit growth subdued. With fiscal consolidation underway, the pace of transition to private demand-led growth in the G3 economies is expected to be gradual. In Asia, growth will be supported by robust domestic demand and a resilient financial sector. While some slowdown is expected, overall economic conditions in the region should stay firm. Against this backdrop, the level of economic activity in Singapore is projected to remain high across a broad range of industries although growth could further ease in the near term. In 2011, the domestic economy will continue to expand but at a more sustainable rate in line with its growth potential.
5 Domestic CPI inflation rose significantly from 0.9% in Q1 2010 to 3.1% in Q2, and edged up further to 3.2% in July-August. While inflation has been largely driven by higher car and commodity prices so far this year, other domestic sources of cost pressures have emerged amidst buoyant economic conditions. For instance, the costs of accommodation and domestic-oriented services accounted for more than half of CPI inflation on a sequential basis in July-August. With the economy already operating at close to full employment, labour cost pressures have picked up and will persist into 2011. Externally, food commodity prices have risen, in part due to the recent supply disruptions. More of these costs could potentially be passed on to consumers in a strengthened domestic economy. Even as base effects dissipate, the build-up in sequential price increases will cause the headline CPI inflation rate to rise to around 4% by the end of 2010 and stay high in the first half of 2011 before moderating.
6 The Singapore economy will continue to expand, although at a slower and more sustainable pace after recovering robustly from the downturn. At the same time, domestic cost pressures are rising, given the high level of resource utilisation in the economy and tight labour market in particular, as well as the diminishing boost from the cyclical uplift in productivity seen earlier this year. Thus, the balance of risks is weighted towards inflation going forward.
7 MAS will therefore continue with the policy of a modest and gradual appreciation of the S$NEER policy band in the period ahead. However, the slope of the policy band will be increased slightly, with no change to the level at which the band is centred. The policy band will at the same time be widened slightly in view of the volatility across international financial markets. This policy stance will remain supportive of economic growth while seeking to cap CPI inflation at 2-3% in 2011 from 2.5-3.0% in 2010, and ensure medium-term price stability. The MAS underlying inflation measure, which excludes the cost of accommodation and private road transport, is expected to average around 2% in 2010 and 2-3% next year.