December inflation in Indonesia rose 1.1%m/m, sa, and leaving it a higher-than-expected 7.0 %oya (J.P. Morgan 6.2%oya; consensus: 6.7%oya). Food led inflation higher in December while increases in other components of the index were modest. Core inflation (ex food and energy) was up a slightly smaller 0.3%m/m, sa and it ticked up to 5.1%oya from 5.2% in November.
Despite the upside surprise in the monthly print, sequential trend inflation showed a more benign trend. Headline inflation was relatively modest at 5.1%3m/3m, saar from a recent peak of 8.7% in September (first chart). Core inflation maintained its slow trend higher, rising to 6.1%3m/3m, saar from a low of 3.6%3m/3m, saar in 2Q10. Like in previous months, the main driver of inflation in December was food prices; this sub-component contributed 0.67%pts to the 0.92%m/m, nsa increase in consumer prices (second chart).
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. However, the expected tweak to energy prices combined with an uncertain harvest in 2Q11 lends upside risk to the inflation outlook for 2011. 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 reach 7.5-8.0%, reflecting to some degree over-year-ago base effects from 2Q10.
Watching April/May inflation – Moreover, the government has recently approved a 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.
The impact of this subsidy move with further food price increases is thus leading to the expectation that more rate hikes will come – with two rate hikes being penciled in during 2Q11 (up from 1 hike) and another in 3Q11. The cumulative hikes are now forecast to increase to 75bps for 2011 from 25bps previously. Although J.P. Morgan had previously suggested that policy tightening will be implemented through liquidity measures, the expected rise in transport costs could broaden inflation transmission on the cost side – and this, if left unchecked could lead to a further transmission to other prices. In this context, liquidity measures maybe less effective than rates. Moreover, while a stronger FX rate could also help slow the inflation pass-through, this will likely be done in concert with somewhat higher policy rates.
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