Disappointing Q2 GDP reduces likelihood of monetary tightening

Nomura expects inflation to hit 2.0% in the next three months from 2.7% in May.

In terms of policy implication, Nomura FX strategist Craig Chan still expects no change to the Monetary Authority of Singapore‟s (MAS) stance but believes the disappointing Q2 print reduces the likelihood of the MAS maintaining its tightening bias in October.

"This bias was primarily based on the elevated inflation during the past several months, so in our view, the key policy consideration is now the path of underlying inflation. We expect underlying inflation to approach 2.0% in the next three months from 2.7% in May which provides the MAS with flexibility in the event external risks intensify," said Nomura in a report.

Here's more from Nomura:

In our last Asia Economic Monthly on 11 June, we wrote that Q2 GDP growth was likely holding up. It now looks like we may be disappointed. The industrial production index (IPI) rose by 6.6% y-o-y in May after falling 0.3% in April (Consensus: 6.1%, Nomura: 7.0%). However, an update of our monthly GDP composite index, taking into account the April-May data for several macro indicators including IPI, suggests that GDP growth seems to be moderating in Q2 from 1.6% y-o-y in Q1 (Figure 1).

This will likely again be led by the services sector (particularly financial and retail services), but even within manufacturing the pick-up in IPI in May looks unsustainable. In fact, the risk is that it could reverse sharply in June given that the pickup in May was driven by volatile biomed output (ex-biomed, IPI growth was only 2% y-o-y), dragging Q2 growth in the process.

This adds further downside risks to our 2012 GDP growth forecast of 2.7%, which is already below potential (3-5% according to MAS estimates).

At the same time, headline inflation is also moderating more sharply. CPI inflation eased to 5.0% in May from 5.4% in April, driven by accommodation costs. While we think it is possible for CPI to stay above 5% in June, we believe that the path in H2 is likely to be lower. Underlying inflation was stable
at 2.7% in May, but the decline in the import price index points to underlying inflation approaching 2.0% in the near term.

The risk to this view is that the labour market remains tight but as the MAS noted, the pass-through from wage costs to consumer prices is going to be at a “more moderate pace than that seen early this year.” Finally, the private road transport component still had a higher contribution to CPI (at 1.2 percentage point from 1.0 in April), but this is likely to ease in response to new measures which allow slightly faster growth of certificate of entitlements by August.

We continue to forecast 2012 average inflation to exceed the MAS‟s 3.5-4.5% forecast range but see the risks as now more balanced rather than tilted to the upside. But in terms of underlying inflation, we also expect that it will fall within the MAS‟s 2.5-3% forecast. Given the emphasis of the latter as a key policy parameter, we think this provides the MAS more policy flexibility to be able to shift to a more neutral stance if external risks intensify at the next policy announcement in October.