SINGAPORE (The Straits Times/ANN): As the war in the Middle East enters its fifth week, central banks in Singapore and elsewhere face a hard decision: head off an oil-driven inflationary shock or move to cushion a likely economic slowdown.
Singapore’s first response to both threats will come in April when the Monetary Authority of Singapore (MAS) announces its latest quarterly policy decision.
Ms Madhur Jha, global economist and head of thematic research at Standard Chartered Bank, noted that four out of five global recessions were preceded by oil shocks.
The Iran war has not only resulted in the effective closure of the Strait of Hormuz – the conduit for one-fifth of the world’s crude oil and liquefied natural gas – but has also cut the supply of key commodities, such as those used in making fertilisers and petrochemicals, and some industrial metals like aluminium.
While the inflationary impact from the energy supply shock is already reflected in rising prices of petrol, diesel, jet fuel and electricity, the hit to growth will gradually build up as industrial input shortages intensify, analysts said.
The Brent crude oil benchmark was at US$115.58 in early hours of trade in Asia on March 30, up about 60 per cent so far in March. Meanwhile, prices of petrol, diesel, fuel oil and jet fuel have doubled over the same period.
Analysts said that if energy prices remain elevated or continue to surge, the impact on costs alone will depress consumer demand for discretionary goods and services, and eventually hit industrial production – which will also suffer the disruption of supply chains due to lack of critical inputs and raw materials.
The Gulf region, for example, is a major supplier of sulphuric acid, which is used in semiconductor manufacturing for the cleaning and etching of silicon wafers.
There is also aluminium, used in cars, planes and solar panels. Prices of the metal jumped about 6 per cent on the London Metal Exchange after Iran on March 29 attacked two plants in the Middle East – one in the United Arab Emirates and the other in Bahrain.
The escalating attacks on the region’s energy and industrial infrastructure mean that even if the conflict ends in the next few weeks, it will take even longer to repair and rebuild damaged plants. Companies and consumers will have to wait for supplies to normalise before prices can return to pre-war levels.
In a monthly inflation report issued on March 23, MAS already said soaring global energy prices will drive up Singapore’s import cost pressures in the near term.
And it signalled it is likely to raise its inflation forecast when it said in the report that it is assessing recent developments and will give an updated inflation outlook in its April monetary policy statement.
Most analysts expect MAS to tighten its monetary policy in April, given the acknowledged inflation risks. They expect the central bank will adjust its stance on the Singapore dollar to seek a stronger currency, which would help curb the impact of higher import costs – a major source of inflation in a country that ships in virtually everything it consumes.
However, any tightening of monetary policy by MAS would be measured amid growing worries about Singapore’s economic growth outlook, said the analysts. A stronger Singdollar could make the Republic’s exports less competitive.
To attain stable, non-inflationary growth, MAS manages the exchange rate of the Singapore dollar against a trade-weighted basket of currencies from Singapore’s major trading partners. This is known as the Singapore dollar nominal effective exchange rate (S$NEER).
MAS does not set the precise level of this exchange rate. Instead, the S$NEER is allowed to move up and down within a policy band, the exact levels of which are not disclosed. If it goes out of this band, MAS steps in by buying or selling Singapore dollars.
The policy band has three levers that MAS can adjust: the slope, the width and the level of the band.
Adjusting the slope will influence the pace at which the Singapore dollar strengthens or weakens.
Widening the policy band will accommodate for more volatility of the S$NEER.
Adjusting the level, or midpoint, of the policy band allows for an immediate strengthening or weakening of the S$NEER, making this a tool for drastic situations such as a recession.
MAS moved the midpoint of the S$NEER upwards thrice in 2022 when energy prices surged amid the Russia-Ukraine war.
However, Mr Ang Kai Wei, Bank of America’s Asean economist, said that this time around, MAS is likely instead to steepen the slope of its policy band by 50 basis points to an annual appreciation rate of 1 per cent.
He said an upward re-centring is likely only if core inflation stays at or above 2.5 per cent for a sustained period. Higher oil prices should also result in a more pronounced and persistent broadening of price pressures.
Mr Ang said one-year-ahead core inflation – which excludes private transport and accommodation costs to better represent household expenses – would reach this 2.5 per cent threshold only if oil prices average US$95 per barrel over the next 12 months. So far, this is an unlikely scenario, he added.
Said Mr Ang: “The hurdle for re-centring seems high, with the oil demand outlook less supportive versus 2022.”
The darkening growth outlook also makes it less likely that MAS would resort to re-centring its policy band.
Singapore’s hopes for above-trend growth have started to fade amid uncertainty about the impact of the Middle East conflict and new US tariffs, although the Government has yet to revise its gross domestic product (GDP) forecast of 2 per cent to 4 per cent for 2026.
While Singapore has the fiscal resources to manage any sudden change in growth outlook, the trajectory of its GDP is still dependent on global demand for its exports.
Mr Ben May, director of global macroeconomic research at research firm Oxford Economics, said a prolonged war in Iran could lead to a global recession in 2026. He said such a scenario assumes that oil prices stay above US$150 a barrel for four months, alongside shortages of refined energy products.
However, in less severe circumstances, global growth could still slow to 1.4 per cent in 2026, before recovering to 2.1 per cent in 2027, Mr May said. In this scenario, recessions would occur in the US and most other major advanced economies, while China’s GDP growth would fall to 3.4 per cent.
“While less severe than the pandemic or global financial crisis, the hit to growth would represent a larger, more coordinated slump than any other global downturn of the past 40 years,” he said.
