Singapore should let its inflation rate rise temporarily to accommodate price gains from tighter labor markets even as those stemming from credit growth should be “forcefully tackled,” the International Monetary Fund said.

Gross domestic product growth is forecast to weaken this year to 2.9 percent, before accelerating to 3.4 percent in 2013, the Washington-based lender said in a report yesterday known as an Article IV Consultation. A low unemployment rate will spur domestic demand and inflation will remain elevated, it said.

The Singapore government this month trimmed its prediction for 2012 growth to 1.5 percent to 2.5 percent, from an earlier forecast for an expansion of as much as 3 percent. Policy makers across the world are girding for a deeper impact from Europe’s sovereign-debt turmoil, with Asian central banks from China to South Korea and the Philippines cutting interest rates last month, putting pressure on Singapore to ease monetary policy.

“Singapore has ample policy space and large buffers to mitigate the effects of a steeper global growth slowdown or financial turmoil,” the IMF said. “Given Singapore’s pronounced trade and financial openness, the impact of further euro-area turmoil, abrupt fiscal tightening in the United States, and/or a severe slowdown in China would be substantial.”

The Monetary Authority of Singapore, which uses the exchange rate to manage inflation, said in April it would allow faster gains in the currency to damp price pressures, diverging from most other regional economies that had left borrowing costs unchanged or eased monetary policy.

The tightening was appropriate, the IMF said yesterday. The central bank releases its next policy review in October.

Under Pressure

“Inflation should be permitted to rise temporarily to accommodate the increase in relative prices of labor-intensive products resulting from the tighter labor market conditions,” the IMF said. “Other sources of inflation -- including from transport costs, credit growth and asset prices -- should be forcefully tackled, including through continued recourse to macro prudential tools. Consideration could also be given to further absorbing liquidity.”

The monetary authority estimated last month consumer-price gains will average 4 percent to 4.5 percent this year, compared with the 3.5 percent to 4.5 percent range it forecast previously. The inflation rate was 4 percent in July, after holding at 5 percent or more in the previous four months.

“Inflation is expected to remain under pressure from the tight labor market and lagged effects of higher prices for vehicle permits and real estate,” the IMF said.

Productivity Growth

Singapore’s government said in 2010 that it aims to at least double its productivity growth to between 2 percent and 3 percent annually in the next 10 years, as it tries to reduce the island’s dependence on exports. Policy makers have cited some industries’ use of cheaper, low-skilled foreign labor as a reason for low productivity in the prior decade, and have tightened rules on hiring overseas workers.

“Slower foreign worker inflows will boost real wages and, if complemented with well-targeted incentives for technology and skills upgrading, should with time support productivity growth,” the IMF said. “In the near term, the strategy is expected to reduce potential growth and increase frictional unemployment. It will also push up inflation and contribute to a permanently more appreciated real exchange rate and narrower current-account surplus.”

Bloomberg