Will deflation persist in 2016?

Core inflation surprised markets.

Singapore's April headline inflation continued its 18th consecutive month of contraction but core inflation surprised markets and hit a 13-mont high of 0.8% y/y, reflecting a jump in services inflatio to 0.7% yoy from 0.4% yoy a month ago. Does this signals an improving outlook for commodity prices?

Here's what analysts had to say:

Suhaimi B Ilias, MayBank KimEng

No change to our 2016 headline inflation forecast at -0.4% (2015: -0.5%) on the dissipating effect of lower global oil prices and Budget 2015 measures that included the reduction in the concessionary foreign domestic worker (FDW) levy, one year road tax rebates, abolition of national examination fees and increase in medical subsidies.

Core inflation to pick up gradually in 2016 as disinflationary effects of oil as well as budgetary and other one-off measures ease. Underlying inflationary pressure still exist contributed by higher food prices (most food supply areimported), upward pressure in labour cost (hence the need to boost labour productivity via automation or skill enhancement) and hence higher cost in
services sector; which are all structural issues in nature. Based on the current global oil market scenario, we had also raised our average Brent price assumption for 2016 to USD40.5/bbl from USD35.0/bbl.

Since 1980s, Singapore had experienced annual deflation in a number of years; 2015: -0.5%, 2002: -0.4%, 1998: -0.3% and 1986: -1.4%. With the exception of 2015, deflation in 2002, 1998 and 1986 were during economic recession period.

Hence, deflation in 2015 and 2016 are during a non-recession year, with the longest streak of negative monthly inflation (based on % YoY change) brought about by lower global crude oil prices contributing to mainly cheaper “housing & utilities” as well as “transport” costs.

Furthermore, Singapore’s positive output gap1 has been gradually diminishing from the recent peak in 1Q 2014 and turned negative in 3Q 2015; a trend which is putting downward pressure on inflation and expected to persist in 2016. As such, growth in 2016 is expected to ease to +1.7% (2015: 2.0%) due to the ongoing structural challenges impacting domestic growth potential; issues such as productivity and labour shortage; as well as fragile growth prospect in the global economy which dampen Singapore’s external demand. In responding to this, the
Monetary Authority of Singapore (MAS) decided to set the rate of appreciation (slope of the policy band) of the SGD NEER to zero percent, beginning 14 Apr
2016. In essence, this removed the modest and gradual appreciation path of the SGD NEER, which was reduced in Jan and Oct 2015. Other policy variables remain unchanged i.e. the width of the policy band and the level at which it is centered.

The last time MAS embarked on the zero percent appreciation policy was in Oct 2008, faced with the dim prospect from Global Financial Crisis (GFC).

OCBC Treasury Research

Our view is that headline inflation may attempt to bottom in 2Q16, but stay subdued for the rest of the year due to the continuing drag from disinflationary asset prices and notwithstanding the slight uptick in global crude oil prices

Francis Tan, analyst, UOB

Headline prices had been contracting for 18 consecutive months, the longest on record, as it broke the previous record of 16 months (Oct 1975 to Jan 1977). However, we hesitate to label the current situation as  a “deflationary spiral”, as the decline in prices were largely due to administrative measures applied on accommodation and private road transport costs. 

Core inflation remains in the positive growth region, unlike during the 2008/09 financial crisis, where core  inflation fell for 9 consecutive months due to a lack of consumer demand as well as corporate/business price-cutting in the aftermath of the global financial crisis. In the current period of slower economic growth,  Singapore’s core inflation had not contracted at all, but in fact had been edging higher over the past few  months. 

That said, global consumer price actions will continue to remain subdued due to the downward pressures  on the prices of major commodities as well as manufactured products. Singapore is a price-taker on this front and will continue to see weak inflationary trend in the months ahead. The Monetary Authority of Singapore had also earlier projected lower trends in both the headline and core inflation for 2016.