Bank Indonesia (BI) left the overnight reference rate unchanged at 6.5% yesterday, as widely anticipated. The post-meeting statement is slightly more hawkish than in the previous month. BI blamed inflation on the jump in food prices, a result of bad weather and supply disruptions. However, BI also recognized the need to “closely monitor the recent rise in inflation” and stated that they“ will pursue the necessary actions to ensure that inflation stays within target”. With regards to possible policy responses in the near term, BI mentioned that they could tighten liquidity management by adjusting banks’ reserve requirement ratios.
As BI prefers to use the RRR instrument first before resorting to interest rates, hence exclude the possibility of a rate hike in September. However, we think rate hikes in4Q10 are still likely. Headline CPI inflation is expected to ease slightly to below 6% YoY in Aug-Sep if food prices stabilize, but will likely return to the 6% level in Oct and rise further to 6.5% in Dec. Consumers’ inflation expectations are rising obviously (170.1 in Jul, up from 163.2 in Jun), on the back of higher prices for a wide range of goods and services and not only food. The risks of inflation pass through and higher core inflation should not be underestimated. Meanwhile, bank lending growth has gathered momentum due to stronger demand and improved interbank liquidity as well as the removal of a significant obstacle to rate hikes (BI has been eager to encourage bank lending). Bank loans rose 19.6% YoY in July (up from 18.6% in June), already approaching the growth trend in nominal GDP of about 20%. Moreover, foreign inflows have remained buoyant to boost liquidity supply. BI said yesterday that foreign reserves stood at USD 78.8bn in July. This means that reserves have increased USD 4.2bn in June-July and fully offset the USD 4.0bn drop in May amid European debt crisis. Despite a smaller trade surplus and the authorities’ tighter regulations on foreign investments in SBI, foreign inflows into the bond markets remained strong with attractive yields and positive sovereign credit rating outlook.
The 2Q GDP is the key data to watch today. Market sentiment is bullish and the Bloomberg consensus expects a strong GDP growth of 6.0% YoY in 2Q, higher than 5.7% in 1Q. Our forecast is relatively conservative, at 5.8%. Export growth has slowed in 2Q and trade surplus has narrowed, while domestic consumption and investment have both picked up to support the overall economy (on YoY basis). Motorcycle sales and motor vehicle sales surged 46.7% YoY and 78.3% YoY respectively in the April-June period (up from 35.4% and 73.6% in 1Q). The realization of domestic and foreign investments rose 55.8% YoY in 2Q, significantly faster than 24.6% in 1Q. However, momentum of the sequential QoQ growth in consumption, investment or headline GDP is still questionable, given the low base a year-ago. Our 2Q GDP forecast of 5.8% assumes a stable QoQ growth of 5.3% (seasonally adjusted, annualized).
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