Singapore widened the trading band for the Singapore dollar on Thursday for the first time since just after the 9/11 attacks on the United States, underlining the depth of its concern about financial markets.
Analysts said the surprise decision gave the currency more flexibility to react to a tide of investment money hitting emerging markets and the potential risk of a flare up in inflation that could result.
"It is to give them more flexibility in a very uncertain world," said Robert Prior-Wandesforde, head of India and South East Asia Economics at Credit Suisse.
"In other words, they could keep their currency towards the top of the band if inflation remains problematic and growth holds up, but also give them more flexibility to push it downwards if growth does falter significantly."
Singapore inflation in August was 3.3 percent, the highest level this year.
Record low interest rates and faltering recoveries in rich countries have pushed investors into emerging markets in search of higher yields, driving up currencies and asset prices.
That has prompted governments to intervene in markets to curb currency strength and to impose some controls, such as taxes, to prevent the funds from destabilizing their economies.
The Singapore dollar hit a record high after the news, which overshadowed data showing the export-reliant economy contracted at a record pace in the third quarter.
The news encouraged further selling of the U.S. dollar, which fell to a 10-month low against a basket of major currencies.
The Monetary Authority of Singapore, the central bank, said the band was widened "in view of the volatility across international financial markets."
The MAS sets monetary policy by managing the Singapore dollar in a secret trade-weighted band against a basket of currencies.
It also increased the slope of the trading band but kept the centre unchanged, effectively tightening policy. It said the changes were also made because "the balance of risks is weighted towards inflation going forward."
"The widening of the policy band is more in response to the unprecedented liquidity in global markets today and to cope with the uncertainty and volatility," said Song Seng Wun, senior economist at CIMB Research.
"The world is awash with liquidity, especially when the U.S. looks to pump even more money to keep its economy afloat."
The last time the central bank widened the trading band for the Singapore dollar was in October 2001, weeks after the plane attacks on New York and Washington D.C.
Analysts said the decision to widen the trading band could also reflect the central bank's need to build in more flexibility into its policies. It schedules policy reviews just twice a year, unlike monthly for many central banks.
Deutsche Bank said in a research note that it believed the band had been widened to plus/minus 3.0 percent from plus/minus 2.0 percent. It said it believed the slope had been increased to 3.0 percent from 2.0 percent.
But it added: "However, given the increased slope, the forward curve is not pricing in the likely pace of appreciation. Inflows into Singapore will thus continue at a strong pace, leading to continued abundant liquidity conditions."
Global currency tensions, underscored by a row between South Korea and Japan over exchange rates, dominated a weekend meeting of the International Monetary Fund. The tensions are also set to dominate meetings of the G20 this month and in November.
"There was criticism at the IMF on emerging markets not doing their part to promote economic rebalancing," said Tim Condon, head of research at ING Financial Markets Research.
"And I think Singapore may be susceptible...they may want to be seen doing their part, or at least not thwarting economic rebalancing by engaging in heavy exchange market intervention.
"They can widen the band and be demonstrating they are prepared to allow a little bit more exchange rate volatility or fluctuation."
Singapore's economy contracted a record 19.8 percent in the third quarter on an annualized and seasonally adjusted basis, following an exceptionally strong first half of the year when the economy rebounded from the global financial crisis.
The government said it was maintaining a forecast for 2010 growth of 13-15 percent.
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