BI’s turn now to act

Statistics Indonesia's (BPS) announcement earlier this week that headline inflation (the prices of all goods and services) in July was 4.94 percent year-on-year, the highest since 2015, should lead to stronger pressure on Bank Indonesia (BI) to rethink its dovish stance, otherwise the expectations of rising prices may become entrenched.

Even though core inflation (excluding energy and food prices) was still relatively low at 2.86 percent and the year-to-date core inflation was only 2.11 percent, the central bank will have to start tightening its monetary policy, especially after the United States Federal Reserve hiked its rate by 75 basis points last week. This cut down the interest rate differential between Indonesian and US bonds to a mere one percentage point.

However, given the huge fiscal support already provided by the government to cushion the inflationary impact of energy prices, BI will be able to make a gradual rate increase, thereby avoiding sudden shocks to domestic demand, which has been the main driver of the post-pandemic recovery, and the government debt-service burden. Most analysts have predicted a cumulative rate hike of 75 basis points between August and December.