SINGAPORE (Dow Jones)–Singapore’s economy contracted more than expected in the second quarter as the city-state suffered from weak demand for its mainstay manufacturing goods.

The disappointing figures prompted a rare swing in the local currency market and economists said a bleak economic growth outlook may preclude the central bank from tightening monetary policy further.

The government’s advance estimate showed that gross domestic product contracted 6.6% in the second quarter from the first in seasonally adjusted and annualized terms, reversing a 15.6% rise in the previous three months.

A Dow Jones Newswires Poll of economists had forecast a 3.9% decline.

Manufacturers throughout Asia have been subject to fallout from slower growth in developed economies, and Singapore’s exporters have also been hobbled by a stronger local currency and faltering demand for key electronics and pharmaceuticals exports.

Analysts said Singapore’s central bank may have reached the end of its monetary policy tightening cycle as further steps could pose excessive risk while the global economy remains in limbo.

“It’s still a close call,” said Kit Wei Zheng, an economist at Citigroup in Singapore. “Slower economic growth will limit the extent of how much the central bank can tighten but you can’t rule out the possibility of more measures in October if inflation surprises on the upside.”

The Monetary Authority of Singapore uses the exchange rate rather than interest rates to conduct policy and manages the local dollar within an undisclosed trading band.

Surging food and energy prices prompted the authority to tighten policy at the last two semiannual meetings and the government has raised its 2008 inflation target several times to the current 5%-6% range.

Hours before the economic growth figures were released, Minister for Finance Tharman Shanmugaratnam indicated the central bank won’t react hastily to further rises in food and energy costs.

“There is a limit to how much we can allow the Singapore dollar to rise to fight inflation that is caused by higher oil and imported food prices. It will require a dramatic strengthening of the Singapore dollar if we wanted to do this,” he said in a speech delivered late Wednesday. “The right approach therefore is to keep our Singapore dollar policy focused on controlling inflation over the medium term and not to try to offset the immediate effects of higher oil and food prices.”

Chance Of Technical Recession

The government now predicts the economy will grow 4%-6% in 2008 after expanding 7.7% in 2007, and most analysts expect growth within that range.

But Standard Chartered economist Alvin Liew warned that slower exports may continue in the third quarter, putting the city-state at risk of a technical recession, defined as two straight quarters of negative growth.

“Singapore will be particularly vulnerable to a protracted external demand weakness,” he said.

The manufacturing sector contracted 5.6% from the same quarter of 2007 after expanding 12.7% in the previous three months.

The services sector helped limit the drag from weak manufacturing, expanding 6.9% from a year earlier after growing 7.6% in the first quarter.

But Singapore’s services sector, which has been led by activity at financial firms, may not offset manufacturing to the same extent in coming quarters.

Slower services growth “hints at a genuine softening in activity,” said Robert Prior-Wandesforde, and economist at HSBC in Singapore.

The construction industry also lost some pace, expanding 15.2% from a year earlier following a 16.9% rise in the previous quarter.

Still, analysts said contractors will remain busy in coming quarters completing billions of dollars in construction contracts for a pipeline of developments and two casino projects.