INFLATION is likely to rise further in the wake of higher manpower costs stemming from tighter foreign worker policies and continued weakness in services sector productivity.

The warning came yesterday from the Monetary Authority of Singapore (MAS), which added that drought in grain-producing countries could send food prices spiking early next year.

It said that its monetary policy stance had been "assessed to be appropriate in containing inflationary pressures and keeping the economy on a path of restructuring towards sustainable growth".

The price of hiring one worker, known as unit labour cost, shot up 4.7 per cent in the first half of this year from the same period a year ago, the MAS noted in its latest Macroeconomic Review.

This was much higher than the 1.7 per cent year-on-year growth in unit labour cost recorded in the second half of last year.

Unit labour costs grew faster than their historical average in all sectors except the information and communications industry and the accommodation and food services segments.

The main culprit for the increase was weak growth in labour productivity in the services sectors, the MAS said. Services accounts for nearly two-thirds of the local economy.

Overall, labour productivity fell 2.1 per cent in January through June from a year ago, reversing a 0.8 per cent year-on-year increase in the second half of last year.

The Government's stricter foreign worker policy, which imposes quotas and levies on firms hiring overseas workers, has led to a manpower crunch and boosted wages, particularly in domestic-oriented sectors, as firms have to compete for a smaller pool of labour.

Wages grew 2.8 per cent in April through June after expanding 0.9 per cent year-on-year in January through March.

Weak productivity combined with heightened labour costs mean the unit labour cost could rise by as much as 3 per cent to 4 per cent next year, the MAS said.

The resulting increase in business costs is likely to be passed on to consumers, it added.

On top of the expected rise in domestic inflation, imported inflation is also tipped to go up next year, mainly due to costlier food.

The MAS pointed to a recent surge in global prices of several food commodities such as corn, wheat and soya beans as the major producers suffered droughts.

This surge is likely to filter through to domestic food prices towards the end of this year and more significantly early next year, the MAS said, warning that rice and meat prices could shoot up if extreme weather conditions associated with the El Nino weather phenomenon intensified.

The combination of elevated labour costs and food price spikes is likely to leave core inflation at between 2 per cent and 3 per cent next year, the MAS said.

Core inflation, which does not include car or housing prices, is expected to average around 2.5 per cent this year.

Overall inflation is tipped to come in slightly above 4.5 per cent mainly because of vehicle certificate of entitlement premiums, and is expected to ease gradually to 3.5 per cent to 4.5 per cent next year.