Economic Analysis - BI To Hike Rates Before End-2017 To Safeguard Macro Stability - SEPT 2017

BMI View: We maintain our expectations for BI to hike its benchmark interest rate by 25bps to 5.00% before end-2017 as inflation continues to pick up, posing downside risks to the IDR as real yields head in favour of the greenback.

Bank Indonesia (BI) held its benchmark seven-day reverse repo rate (7-day RR rate) unchanged at 4.75% at its monthly monetary policy meeting on 19-20 July. At the same time, the corresponding deposit and lending facility rates were also kept constant at 4.00% and 5.50%, respectively. According to BI's statement, the decision came amid a weaker-than-expected economic growth recovery, while inflationary pressures remain manageable. Given that the IDR remains stable against the USD, we believe that BI has the policy room to keep rates on hold over the near-term. That said, we maintain our expectations for BI to hike rates by 25bps to 5.00% before end-2017 as inflation continues to pick up and downside pressure on the rupiah re-emerges as real yield spreads head in US's favour.

Inflation in Indonesia inched up to 4.4% y-o-y in June 2017, from 4.3% y-o-y in the previous month, and the highest level recorded since March 2016. Despite the uptick in price pressures, BI noted that inflation came in below its projection, which likely allowed it to keep rates on hold. Over the coming months, we expect higher grain and oil prices and a likely acceleration in money supply growth - due to the authorities' plan to ease the minimum statutory reserve requirement (to 5.0%, from 6.5% previously, effective July 1) to raise credit growth - to keep inflation on a gradual uptrend. It is therefore likely that BI will hike interest rates by the end of 2017 in a bid to prevent inflation from accelerating beyond the upper band of its inflation target, informing our forecast for headline inflation to end 2017 at 4.6%.

Looking Technically Positive
Indonesia - Exchange Rate, IDR/USD
Source: Bloomberg, BMI

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