Indonesia: BI hikes policy rate to anchor inflation expectations - JP Morgan

Against expectations, Bank Indonesia hiked its policy rate 25bps to 6.75% (J.P. Morgan and Consensus: unchanged).

Bank Indonesia today hiked its policy rate in anticipation of rising inflation expectations, driven by the recent rise in commodity prices and the expected increase in transport costs at the beginning of 2Q11.

J.P. Morgan had expected the central bank to only hike rates at the April 5th policy meeting following the hike in transportation costs which were expected to lift core inflation as has been the case historically (chart). Instead, Bank Indonesia has been more pro-active than expected, moving two months ahead of the initial J.P. Morgan forecast. The reaction by BI to rising inflation expectations and rising price pipeline reflects well on the central bank and suggests a more pro-active stance towards anchoring inflation setting behavior.

Despite the earlier than expected move by BI to hike its policy rate, the forecast trajectory for another 50bps hike in rates remains in place to bring policy rates to 7.5%, with the next 2 25bps hikes expected at the March 4 and April 5 meetings respectively.

The forecast trajectory thereafter will depend on two factors. The first will be the inflation trajectory following the April transportation price hikes and also from the expected rice harvest in 2Q11, which is forecast to come in around 5% lower than 2010. That said, BULOG (The State Logistics Agency) has been active in increasing its rice stockpiles through regional imports and this should help mitigate the expected increase in domestic rice prices. The second factor that is expected to influence the BI’s response will be inflation expectations as reflected in the BI’s consumer sentiment indicators. In the event that expectations turn lower, this would be another signal that the BI’s hikes have succeeded in anchoring inflation setting behavior.