Bank Indonesia to keep policy rate at 6.75% till year-end

It was no surprise that the central bank (BI) opted to keep the policy rate unchanged at 6.75%. Headline inflation in August is still well-behaved and the high core inflation number has probably been distorted by the spike in gold prices. Moreover, concerns across Asia have shifted towards growth following several weeks of volatility in the equity markets. These concerns are also reflected in BI’s statement.

With food and oil prices staying stable, we have decided to revise down our inflation forecast for this year from 6.0% to 5.7%. For 2012, we have nudged down our projection from 6.3% to 6.1%. The government is expected to incrementally phase out fuel subsidies by 2014 and may opt to raise subsidized fuel prices next year, thereby leading to a one-off spike in the CPI. Without an increase in fuel prices next year, inflation would be around 5.7%. 

With inflation unlikely to be a concern for the coming few months, we now expect BI to leave the policy rate unchanged at 6.75% through the end of the year. Noting that BI has also widened the lower band of the interest rate corridor for monetary operations from 100bps to 150bps (an implicit form of monetary easing), there have also been suggestions that a rate cut may be on the cards in the coming months.

Such concerns are premature at this point and it will largely be dependent on further signs of deterioration in the global economy. With the domestic economy likely to remain robust, core inflation should maintain an upward drift in the coming quarters. Monetary tightening is projected to be kick-started again in 1Q and we have a total of 75bps worth of rate hikes penciled in for 2012.