Bank Danamon Rate cuts decelerated Why?

Rate cuts decelerated: Why?
By Helmi Arman Economist Treasury & Capital Markets PT Bank Danamon Indonesia, Tbk

Apr-09 Mar-09 Feb-08 Jan-09 Dec-08
Bank Indonesia Policy Rate 7.50 7.75 8.25 8.75 9.25
Headline CPI (% chg y-o-y) n/a 7.92 8.60 9.17 11.06
Headline CPI (% chg m-o-m) n/a 0.22 0.21 -0.07 - 0.04

Source: Bank Indonesia, BPS, CEIC

Economic Highlights

* After cutting 50bps in the previous month,Bank Indonesia cut its policy rate by only 25bps today to 7.50%. This month's cut was milder than our expectation but in-line with consensus.

* The deceleration comes despite signs of further deterioration of economic growth and easing inflation. However it may be signaling BI's cautiousness on inflation prospects after 2009. There may also have been wariness over Indonesia's interest rate differentials which were cited as being negative in "covered" terms, although we think interest rate differentials are currently very far down on the list in explaining recent exchange rate movements.

* Policymakers indicated there may still be more room for further rate cuts. This is consistent with our view and we think the BI rate might bottom at 7.00% this year. However it may move at a slower pace going forward; we expect two more 25bp rate cuts in May and June.

* Separately BI announced foreign reserves stood at US$54.8bn, up from 50.6 in Feb. This should be viewed positively. The increase appears attributable to more than the US$3bn global MTN issuance of early March, suggesting there may have been improvements in other components of the BOP such as (probably) the current account.


Market Implications
* BI's deceleration of rate cuts might serve to tone down market expectations on where the rate cycle will bottom. With the 1-yr t-bill currently yielding about 9.3%, we don't think the market has fully priced-in a 7.00% bottom for the BI rate yet. Nonetheless although the price impact of even a 0.5ppt yield decline in the 1-yr is relatively modest, we still think the short-end remains the part of the curve that will remain well-anchored.

* Monetary policy transmission?As for as March data goes, the base lending rate has only moved down marginally (see chart 2). This condition will probably persist until the full extent of the current economic slow-down becomes clearer. Meanwhile average deposit rates have eased by a relatively larger extent, although still slower than what many policymakers may desire. Nonetheless, we hope the continued rise in interbank market trading volumes should be a positive trend that would allow deposit rates to go down further going forward.