Credit Suisse Indonesia: Inflation outlook has worsened

Strong July CPI may trigger a swift rate hike

• Strong volatile food prices and an electricity tariff hike have driven up July CPI inflation to 6.22% yoy, exceeding the target set by Bank Indonesia (BI) for 2010. More concerning is that the rise in core CPI inflation has also accelerated.

• We think Indonesia’s inflation outlook has worsened. While volatile food prices may ease, the rise in demand-pull inflationary pressure is of concern. We now expect the year-end inflation rate to range between 6.5% to 7%, above our previous forecast and BI’s target range.

• We think BI may raise the policy rate by 25bp soon, possibly at the 4 August meeting. This would be to pre-empt the rise of inflation expectations and the overly rapid build-up of demand-pull inflationary pressure. Risk of a second rate hike this year would increase, in our view, if core inflation keeps surprising on the upside.

• The rise in headline inflation should still be paced over 2H10, as rice production is forecasted to remain sufficient this year, while stable global fuel prices and a strong IDR should help mitigate the price pressure. We do not expect a cut in the government fuel subsidy this year.