August 2, 2024
JAKARTA – The lowest inflation in more than two years, coming on top of monetary policy signals from the United States, could give Bank Indonesia (BI) the space to reduce its interest rates before the end of the year.
Statistics Indonesia (BPS) interim head Amalia Adininggar Widyasanti announced at a press conference on Thursday that consumer price index (CPI) growth slowed to 2.13 percent year-on-year (yoy) in July, the lowest rate since February 2022.
Consumer prices have been decreasing for three months in a row, with the CPI dropping 0.18 percent month-to-month (mtm) in July.
Amalia said annual headline inflation rate was being pushed up chiefly by the “food, beverages and tobacco” expenditure category.
Nevertheless, July’s volatile food inflation of 3.63 percent marks a new low this year and a significant improvement from 5.96 percent logged in the preceding month.
Headline inflation has been declining steadily since March 2024 and has remained since May 2023 within BI’s target range of between 1.5 and 3.5 percent this year and between 2 and 4 percent last year.
Yet the central bank has kept its benchmark BI-Rate high since the beginning of 2023, even raising it by 25 basis points last October and again this April to the current level of 6.25 percent.
The disinflation seen over the past months could give BI room to cut lending rates, but domestic inflation is not the only factor the central bank considers in its monetary policy decisions.
The central bank also needs to keep an eye on the decisions of the United States Federal Reserve (Fed), since Indonesian bonds might lose their appeal if the BI-Rate is set too close to the US’ federal funds rate (FFR), as investors generally place a risk premium on Indonesian bonds.
The interest rate differential ensures demand for Indonesian debt obligations, thereby preventing currency outflows that could weaken the rupiah and lead to imported inflation that might increase the country’s CPI.
Hence, BI regularly notes exchange rate stability as one of its key considerations in monetary policy.
At its last board of governors meeting, BI Governor Perry Warjiyo said the central bank might start cutting its rate in the fourth quarter at the earliest, upon its projection of a Fed rate cut in November.
Read also: BI sees Fed rate cut only in November, projects own cut in Q4
The US central bank left the FFR untouched in its policy meeting on Wednesday, but Fed Chairman Jerome Powell gave his strongest signal yet that the high rate cycle might soon be over, according to analysts.
“If we were to see inflation moving down […] more or less in line with expectations, growth remains reasonably strong and the labor market remains consistent with current conditions, then I think a rate cut could be on the table at the September meeting,” Powell said, as quoted by Reuters.
The Fed and BI are both scheduled to hold their next policy meetings on Sept. 17 to 18.
Analysts say BI is likely to wait for the Fed to start its rate-cutting cycle first, since the current FFR of between 5.25 and 5.5 percent is not too far off from the BI-Rate.
Bank Permata chief economist Josua Pardede told The Jakarta Post on Thursday that Indonesia’s monetary authority was unlikely to take action before the Fed. While he acknowledged that many traders were expecting FFR cuts in September, November and December for to a total of 75 basis points (bps), he begged to differ.
“We see the possibility of a [total] 50 bps Fed cut in September and December, in consideration of the US presidential election [in November] and [that] crude oil prices are inclined to rise nowadays, [as] US crude reserves are starting to go down,” said Josua.
He said the door to a BI-Rate cut would open in October, but he still expected the central bank to maintain its current rate until the end of the year.
“However, we are now considering the possibility that BI may cut the BI Rate sooner, if both external and domestic conditions align with [the required] scenario,” he added.
Read also: Soft dollar keeps yen aloft as Fed hints rate cuts on the way
External factors for that scenario included multiple FFR cuts and containment of geopolitical tension to avoid driving up oil prices significantly, while domestic factors consisted of softening inflation in the second half and no significant risks from the planned excise on plastic goods and sugar-sweetened beverages.
Bank Danamon economist Hosianna Evalita Situmorang told the Post on Thursday that BI would have room in the fourth quarter to lower the BI-Rate by “at least 25 bps”.
The cut could be made only in the fourth quarter and not sooner, she explained, because the rupiah’s exchange value was “still pretty much under pressure”. The final quarter of the year was also when the government would be entering the transition period, with a “potential increase in the current account deficit”.