What you need to know about the 'massive drop' in April inflation

It plunged to 1.5%.

According to DBS, April inflation unexpectedly plunged to just 1.5% YoY. That’s a massive 2%-pt drop from 3.5% in the previous month. While everyone in the market has expected a significant moderation, it appears that the correlation between the plunge in COE premiums and the CPI inflation has been underestimated.

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Indeed, the drop in the transport CPI inflation has been the key factor. In particularly, it was due to the private transport cost index, a subindex for overall transport CPI, which on its own accountsfor a significant 11.7% ofthe overall CPI basket.

And this sub-index is mainly driven by the COE premiums. So considering the fact that average COE premium has dived by about 20% YoY in April, it probably explains why the headline inflation figure has dropped so drastically.

Tighter financial terms on car purchases introduced by the MAS earlier have hit car demand. Essentially, cars with an Open Market Value (OMV) that does not exceed SGD 20,000 will now face a maximum loan to value (LTV) of 60%. For a motor vehicle with OMV of more than SGD 20,000,the maximum LTV is now 50%.

This is down from a maximum LTV of 100% previously. Furthermore,the tenure for vehicle loan has also been capped at 5 years.

These changes essentially imply substantially more cash up-frontfor consumers, which in effect, have slammed the brake on car demand and COEs.

This is the main reason why COE premiums have fallen sharply and thereby creating the significant knock-on effect on CPI inflation. However, underlying cost pressure is still high and the labour market isstill tight. Wage pressure is expected to rise in the later part ofthe year when growth momentum picks up.

Moreover,such pullback in inflation as a result of the policy shift will be transient and will probably lastfor only 12 months before itsimpact on inflation lapses due to base effect. In fact, inflation is expected to rise above the 3% levelfrom April next year onwards unlessthere is more disinflationary pressure.

But in the near term, the point to note is that this major policy change has drastically lowered the trajectory ofthe inflation profile. That is, even if we maintain the sequential profile of our inflation forecast constant, full yearinflation will be significantly lowerthan previously anticipated due to this policy shift.

With this in mind, we have lowered ourinflation expectation for 2013 to 2.8%, down from 3.6% previously. The inflation forecastfor 2014 has also been recalibrated to 3.6%,from 4.2%.