Singapore's inflation rose sharply in March, driven by escalating costs of housing and automobiles, suggesting that the central bank could tighten monetary policy further to prevent overheating, especially in the housing sector. 

The consumer price index (CPI) climbed to 5.2 percent in March from a year earlier and core inflation ran at 2.9 percent while wages increased by 6 percent in 2011, data released by the department of statistics showed Monday. The Monetary Authority of Singapore (MAS) expressed worry that tight labor market conditions will keep inflation high in the coming months.

The growth in credit was to a certain extent responsible for the inflationary pressure, with bank loans and advances climbing by 27.6 percent in February. In a clear indication that inflation could rise further, credit growth has raced ahead of nominal gross domestic product (GDP) growth rate. Between mid-2007 and the end of 2011, bank lending to the private sector rose from 80 percent of the rate of GDP to 111 percent.

In another indication that the economy of Singapore is overheating, new home sales topped 2,000 for two months in a row for the first time, with data showing that 2,393 new homes were sold in March.

An increase in demand as a result of strong population growth is one of the reasons behind the rise in house prices in recent years. “The housing market is undoubtedly looking frothy, with the house price to income ratio approaching the highs reached before the Asian financial crisis, when house prices subsequently fell by more than 40 percent,” Daniel Martin of Capital Economics said.

Both robust credit growth and mounting house prices originate to some extent from low interest rates, which in turn are a consequence of the policy framework followed by the MAS. Different from most central banks, which adjust policy interest rates to manage the economy, the MAS uses a policy band for the Singapore dollar. Considering that the economy of Singapore heavily depends on trade, this policy of MAS is an effective method of managing economic growth and inflation, but consequently, it has left the MAS with little control over domestic monetary conditions.

After the beginning of the global financial crisis, Singapore has been importing low interest rates from the US but the Singapore Interbank Offered Rate (SIBOR) cannot fall much more. This will mean that the MAS will have to look for other options to avoid overheating.