How the 'COE effect' could nudge inflation up to 2.3% in October

But base effect is seen to lapse soon.

According to DBS, the headline number is creeping up and will likely record 2.3% YoY in October.

This is up from 1.6% in the previous month but it shouldn’t come as a surprise given the recent increase in the COE premiums. The base effect will lapse from October onwards, which spells higher transport inflation ahead.

Here's more from DBS:

Premiums on average are about 10.7% higher compared to the same period last year and about 7.7% more than the level registered in September.

We estimated the increase in the COE premium alone will add about 0.6-0.7%-pt to the headline number.

Beyond the COE effect, the tightening in foreign labour policy will only continue to drive labour cost higher, particularly when the domestic labour market is already so tight. Moreover, overall business cost is still rising. Profit margins have been compressed and companies will surely continue to pass on the pain to consumers.

With the underlying cost pressure in the domestic economy still high, the trajectory on inflation is still up. We continue to maintain the view that inflation could potentially cross the will cross the 4% mark by April next year and average 3.2% in 2014, up from 2.5% this year.

And that makes for a continued tightening bias on the exchange rate policy, particularly when growth momentum is picking up.