JPM Indo: January CPI above expectations – BI to remain pat on Feb 4

January inflation in Indonesia rose 0.5 %m/m, sa, and leaving it a higher-than-expected 7.0 %oya (J.P. Morgan and consensus: 6.9%oya). Food led inflation higher in January while increases in other components of the index were generally modest. Core inflation (ex food and energy) was up a slightly smaller 0.3%m/m, sa and printed 5.0%  from 5.1% in December.

As in previous months, the main driver of inflation was food prices, which contributed 0.57% pts to the 0.89%m/m, nsa increase in headline CPI (first chart). Of the 0.32%pt increase in non-food prices, 0.12%pts owed to the housing, electricity sub-index – owing to the hike in residence fees. Aside from the hike in the housing sub-index, other non-food sub-indices were benign.

Inflation outlook lifted by food and fuel - Taken on its own, the outlook for inflation remains broadly modest with core inflation marking a slow drift higher and headline inflation mainly reflecting the volatility in food prices (second chart). However, the expected tweak to energy prices combined with an uncertain harvest in 2Q11 lends upside risk to the inflation outlook for 2Q11. These two factors are expected to lift cumulative inflation in Indonesia to between 7.0-7.5% in 2011 (an average monthly run rate of 0.6%m/m, nsa) from 6.20% in 2010 (with an average run rate of 0.52%mm, nsa). With this run rate, full year over-year-ago inflation is expected to peak at 8.0-8.5%oya in 2Q11, reflecting to some degree over-year-ago base effects from 2Q10 but also from the broadening in other prices following the expected hike in transport costs.

Watching April/May inflation – Moreover, the government has recently approved to stop private cars (excluding public transport vehicles and motorcycles) from using subsidized fuel with the program expected to be rolled out in phases starting at the beginning of 2Q11 in West Java and Jakarta. The inflation impact from the subsidy change needs to be watched, especially in view of the impact on other indirect costs which will include logistic costs, given the prevalence of private transport for goods. The assumption here is that the subsidy shift could provide an opportunity for retailers to raise prices across the board and this is to an extent reflected in the J.P. Morgan inflation forecast. Another risk that needs to be watched in 2Q11 is the impact of the recent wet weather on the upcoming rice harvest in April/May of 2011. That said, the variability around this forecast reflects the uncertainty around the rice harvest in 2011 and its impact in setting the tone for the inflation trajectory for the rest of 2011 and also from the uncertain impact that the price increase would have on the broader set of logistical costs, which may well get passed on in some shape or form.

Timing of BI action expected to coincide with rise in core prices – Although the market expectation is split for a BI rate hike at the upcoming policy meeting on February 4, J.P. Morgan only expects the first hike in April 2011, following the increase in transportation costs.

One observation about recent Indonesian inflation is that it has mainly been driven by food prices (even as non-food prices have been generally benign), which is beyond the influence of monetary policy (third chart). J.P. Morgan is sympathetic to this view. However, the main risk will be when the key inputs – transport prices – are hiked in 2Q11; this could lead to a broader increase in overall prices. This time frame thus lays the groundwork for a hike in policy rates in 2Q11 to anchor inflation setting behavior.