July 3, 2024
JAKARTA – Consumer price growth has slowed again, but experts see no room for Bank Indonesia (BI) to reduce its benchmark interest rate because doing so would put more pressure on the rupiah and a further depreciation of the currency could lead to imported inflation.
The headline inflation rate, or annual consumer price index (CPI) growth, dropped to 2.51 percent in June, according to Statistics Indonesia (BPS) data published Monday, which marks a further drop from 2.84 percent logged in the preceding month.
BPS chief secretary Imam Machdi revealed in a press briefing on the same day that “food, beverages and tobacco” was the group that contributed the most to CPI growth last month, accounting for 1.4 percentage points of the 2.51 percent rise.
Prices of volatile food items were up 5.96 percent year-on-year (yoy) in June, but that marks an improvement from a reading of 8.14 percent yoy logged in May.
Headline inflation has been declining since March and has remained within BI’s target range since May last year.
The target range for 2024 is between 1.5 and 3.5 percent, while last year’s was 2 to 4 percent. Before May 2023, BI was battling elevated price pressure, along with central banks in many other countries.
The downward inflation trend should ideally create space for BI to cut lending rates, but the central bank has kept its benchmark BI rate high since the start of last year and even raised it by 25 basis points in October of 2023 and again in April this year, lifting it to the status quo of 6.25 percent. BI Governor Perry Warjiyo attributed both hikes to intensifying global uncertainty, as the United States Federal Reserve keeps its hawkish stance and geopolitical tension brews in the Middle East. The main concern for the October hike was rising oil prices as the risk of the Israel-Hamas conflict escalating into a regional war loomed large. The April hike was seen as a measure to buttress the rupiah as the Indonesian currency was trading near a multiyear low against the US dollar. The exchange rate found a footing for a while after BI’s move, only to rapidly descend again in mid-June, when it hit another multiyear low of Rp 16,419 per US dollar.
That decline was primarily driven by the hawkish stance of the Fed, which appears to be in no hurry to reduce its benchmark interest rate from the current range of 5.25 percent to 5.5 percent, prompting investors to ditch emerging market currencies including the rupiah.
A weaker rupiah could translate into higher CPI growth because of the impact of imported inflation, as depreciation of the local currency would push up the prices of imported products and raw materials in rupiah terms, making such goods more expensive for Indonesian consumers and producers.
The risk of imported inflation leaves BI with no room to cut interest rates for the time being, experts contend.
BCA chief economist David Sumual told The Jakarta Post on Monday that the central bank would likely hold onto the current rate until the Fed started cutting its benchmark rates.
“The probability of BI lowering [rates] is low. The space will only probably open when the Fed starts cutting, because inflation is affected by the prices of imported goods,” David said.
He explained that there was “a lag” in the transmission of a weaker exchange rate to higher inflation, since most companies would not immediately increase the prices of their goods at the consumer level “since people’s purchasing power is weakening somewhat”, in part thanks to food becoming more expensive.
However, David noted that price pressure on imported goods at the wholesale level remained low, particularly for imports from China.
While he sees little chance of a BI rate cut, David highlighted that a raise “is still possible”, especially if the rupiah comes under more pressure.
Bank Permata chief economist Josua Pardede told the Post on Monday that BI was likely to keep its rates unchanged and only embark on a rate-cutting cycle in the first quarter of next year, while keeping its eyes on global uncertainty that was putting pressure on the rupiah, the risk of imported inflation as well as the anticipated Fed rate cut, possibly in December.
“Given that headline inflation and core inflation remain stable within the target range, inflation is estimated to not exert too much pressure. This will give BI enough flexibility to hold or even cut interest rates in the future,” Josua said.
Bank Danamon economist Hosianna Evalita Situmorang projected in an analysis published on Monday, after the publication of the latest inflation data, that CPI at the close of the year would be 2.9 percent.
“On the policy front, we anticipate [that] Bank Indonesia will hold the policy rate at 6.25 percent in this month’s meeting to safeguard rupiah stability, while preventing an upside risk to inflation,” Hosianna said.