Economy May inflation data have reinforced the expectations that BI will keep policy unchanged next week - DBS Vickers

May inflation data came in as generally expected. Headline CPI inflation eased slightly to 6.2% YoY in May from 6.2% in April, again helped by the slowdown in food prices. Core inflation rose 4.6% YoY, a similar rate as in the previous month. While headline inflation still exceeds the ceiling of BI’s policy target of 4-6%, core inflation has not yet reached an alarming level. And the inflation-adjusted real rate (overnight) remains in the positive territory. As inflation numbers are benign and uncertainty in the global economy has increased, chances are high that BI will opt to leave rates unchanged at 6.75% at the upcoming monetary policy meeting scheduled next Thursday.

Going forward into the second half, we still believe the risks to inflation and interest rates are on the upside. The downward trend in inflation has in fact slowed in May compared to in Mar-Apr. As the local harvest has already passed the peak, food prices fell -0.3% MoM in May, a much smaller degree of decline compared to -1.9% in the preceding two months. A rebound in fresh food prices is expected soon in 3Q, taking into account the end of harvest season and the arrival of the Ramadan festival. Meanwhile, despite the drop in global oil prices in May, the gap between the unsubsidized and subsided fuel prices in Indonesia remains wide and the government may still consider a fuel price adjustment in the second half. Excluding food and fuels, the underlying inflation pressures are also expected to increase in 2H, as indicated by a significantly positive output gap, strong expansion in money supply and resilient growth in consumption demand. We maintain our forecast that BI will hike rates by a cumulative 75bps to 7.5% by the year-end.