Chart of the Day: A closer look at the central bank's monetary policy dilemma

MAS is trapped between a rock and a hard place.

As global foreign exchange volatility escalates, all eyes are now on the Monetary Authority of Singapore's move at its upcoming monetary policy statement in October. With an economy under threat from technical recession, pressure is mounting for the central bank to ease policy again, mirroring an unscheduled policy move in January this year.

However, monetary policy has a dilemma, as this chart from CIMB shows. The central bank's decision to reduce the slope of the policy band and loosen the nominal effective exchange rate (NEER) in January means that the SIBOR--the short-term interest rate on which most loans are pegged--has firmed since then.

"Essentially, policy must decide what the slowing economy is more sensitive to – rates or the currency. If it is rates that could cause the most damage, then policy needs to be “tightened” from here – allow NEER to appreciate – so rates can come down. If it is currency, the current stance will likely be maintained, where the SGD weakens in line with regional currencies and domestic rates go up," CIMB said.  

CIMB believes that the status quo will be maintained for now, but things might change if the economic slowdown grips further.

"Given the leverage in the local economy, the focus is likely to shift toward lower rates. Largely based on our view that the external environment is going to be harsher than people think, we think the risk to Singapore growth is to the downside, i.e. lower than the 2.2% consensus estimate. In the event rates need to come down, paradoxically, monetary policy will need to be tightened," the report said.