By Xinghui Kok
SINGAPORE, July 27 (Reuters) – Singapore’s central bank tightened its monetary policy settings unexpectedly on Monday, with inflation projected to step up in the months ahead.
Singapore’s central bank has a unique method of managing monetary policy, tweaking the exchange rate of its currency instead of changing domestic interest rates like many economies.
The Monetary Authority of Singapore (MAS) sets the path of what it calls the policy band of the Singapore dollar nominal effective exchange rate (S$NEER), thus strengthening or weakening the local currency against those of its main trading partners.
WHY DOES SINGAPORE USE THIS METHOD?
Singapore is a small and trade-reliant economy. Gross exports and imports of goods and services are more than three times its gross domestic product (GDP). Almost 40 cents of every Singapore dollar spent domestically is on imports.
That means the exchange rate has a much bigger influence on inflation than domestic interest rates.
For example, an appreciation of the Singapore dollar against the currencies of its major trading partners will reduce prices of imported goods and services. This dampens the prices that households have to pay.
WHAT IS THE S$NEER?
The S$NEER is an index of the Singapore dollar’s trade-weighted exchange rate against the currencies of the island’s major trading partners.
The central bank says this allows the Singapore dollar to perform collectively in relation to its major trading partners, which is what matters for general price levels in Singapore.
HOW DOES THE S$NEER POLICY BAND WORK?
MAS does not set the precise level of the exchange rate or control it in real time. Instead, the S$NEER is allowed to move up and down within a policy band, the exact levels of which are not disclosed. If it goes out of this band, the MAS steps in by buying or selling Singapore dollars.
The policy band has three parameters that the MAS can adjust. Until 2024, these parameters were reviewed at least twice a year, typically in April and October.
Additional reviews can be held if conditions demand an immediate change in settings, such as in 2022 when high inflation triggered two off-cycle moves.
From 2024, the central bank started making monetary policy announcements every quarter, saying it allowed policymakers to provide their assessment of the economic outlook in a more timely fashion.
The three policy levers are the slope, the level and the width of the band.
Adjusting the slope will influence the pace at which the Singapore dollar strengthens or weakens.