By Masayuki Kitano and Jongwoo Cheon
SINGAPORE (Reuters) - Singapore's central bank on Friday held policy steady despite a surprisingly sharp economic contraction in the third quarter, but analysts say the weak inflation and growth outlook will likely force policymakers to ease further.
After a brief bounce, the Singapore dollar quickly turned lower, falling as much as 0.4 percent to 1.3865 against the U.S. dollar, nearing a seven-month low set on Thursday, as traders took stock of the grim gross domestic product numbers.
The affluent city state's open economy has felt the brunt of a global slowdown and a downturn in commodity prices, while a cooling in Singapore's major trading partner China has put the shackles on the domestic manufacturing sector.
Singapore's economy contracted by 4.1 percent in the third quarter on a seasonally adjusted annualised basis, from the previous three months, the biggest slump since 2012, data from the statistics office showed. Forecasts had centred on 0.3 percent growth.
Despite the weak GDP figures, the Monetary Authority of Singapore (MAS) said in a statement it would keep the width of the policy band and the level at which it is centred unchanged, maintaining the rate of appreciation of the Singapore dollar policy band at zero percent.
"The current policy band provides some flexibility ... to accommodate the near-term weakness in inflation and growth," the MAS said in its semiannual policy statement.
But a number of analysts expect the MAS would be forced to ease in coming months.
"The bigger story is that GDP was very, very weak," said Michael Wan, economist at Credit Suisse in Singapore.
"MAS risks being behind the curve. They should ease – inflation is low, growth is slow and slowing and it looks like it's not going to improve anytime soon."
Particularly worrying for economists, the manufacturing sector shrank 17.4 percent, due to a decline in transport engineering and the volatile biomedical sector. Even the once-vibrant services sector contracted for the third consecutive quarter.
The MAS manages monetary policy by changes to the exchange rate, rather than interest rates, letting the Singapore dollar rise or fall against the currencies of its main trading partners based on its nominal effective exchange rate (NEER) because trade flows dwarf the city state's economy.
Sixteen of 18 analysts in a Reuters survey had predicted that the MAS would keep monetary policy unchanged this month. In April, the central bank unexpectedly eased policy.
SIGNS OF SLACK
Economic growth in the city-state has remained anaemic in the past two years and analysts worry about the paucity of catalysts to spark momentum any time soon. Entire floors at central shopping malls are vacant as weak domestic demand has hurt retailers while a slowing global economy has meant tourists have less money to spend. Most industries face a labour shortage exacerbated by immigration curbs and wages are running well ahead of productivity. Vacancies in office and residential buildings hit multi-year highs. The downturn in commodities has hurt the offshore and marine industry, with debt woes engulfing companies such as Swiber Holdings Ltd, Swissco Holdings LTD and Rickmers Maritime. Even the financial industry, which has put the tiny 51-year-old island city on the global map, is under pressure as its once-booming private banking sector struggles under tougher compliance rules.
The services sector contracted 1.9 percent in the third quarter. The MAS expected 2016 economic growth to come in at the lower end of the 1-2 percent forecast.
Medium-term core inflation was seen trending towards, but average slightly below 2 percent, while all-items inflation has bottomed, it said.
"Our base call ... is that we will get a re-centering in April," RBS economist Vaninder Singh said, referring to a possible one-off depreciation of the Singapore dollar.
(Additional reporting by Aradhana Aravindan, Saeed Azhar and Anshuman Daga; Writing by Marius Zaharia; Editing by Shri Navaratnam)