JPM Indo economics: tracking recent inflation trends (Sin Beng Ong)

* Recent inflation driven mainly by food prices; nonfood inflation has been modest of late
* Pipeline inflation remains well behaved; though nearterm rise in food is expected it should roll off in 4Q10
* Bank Indonesia to respond in 1H11 with modest hike even as sequential inflation eases

The recent inflation data from Indonesia have come in higher than expected, which has raised the specter that inflationary pressures are rising and that Bank Indonesia has been slow to address the turn in inflation. While J.P. Morgan expects that inflation will likely break above the 6% top of the central bank’s inflation target in 4Q10, this should be transitory, and the underlying sequential trend should ease during 4Q10 even as over-year-ago inflation remains elevated. It is expected to peak at around 7.0%-7.5%oya in 1Q11 (first chart). Bank Indonesia’s response is thus expected to be modest; we are penciling in a 25bp hike for 1H11 (second chart).

Part of this judgment reflects the relatively idiosyncratic and temporary nature of the recent food price uptick and that underlying pipeline pressures remain modest. Moreover, unlike in previous years, the balance of payments remains solidly positive and thus should facilitate further FX appreciation as an added tool to anchor the price transmission from food into core inflation (see “Indonesia’s BoP to lean more on capital account,” GDW, June 11, 2010). The main risk to this otherwise benign forecast is if the recent increase in food prices proves to be a secular uptrend and if nonfood commodity prices rise more than forecast.