● Bank Indonesia (BI) kept the benchmark 7-day reverse repo rate at 3.50% for the 16th straight month at its sixth Board of Governor meeting this year. The decision, on June 23, was in line with house and market expectation

- The Deposit Facility and Lending Facility rates were also kept at 2.75% and 4.25%, respectively.

- BI statement: The decision is consistent with the need to control inflation and maintain exchange rate stability while continuing to support domestic economic growth amid heightened external pressures brought by the risk of stagflation in several countries.

● Growth recovery to remain intact, while signalled adjustment in policy rate if core inflation accelerates

- GDP: BI sees the recovery in the domestic economy to remain intact, driven by the growing domestic demand and solid export performance as reflected by several highfrequency indicators in May 2022. This was supported by expansion in key sectors such as the manufacturing industry, trade and construction. Nonetheless, BI maintained its domestic growth projection at 4.5%-5.3% (2021: 3.7%).

- Inflation: BI expects inflationary pressure to increase due to elevated global energy and food prices and supplyside pressures with headline inflation projected to hit its target band of 2.0%-4.0% before returning in 2023. Based on the statement, BI is ready to adjust interest rates if core inflation accelerates. Currently, core inflation remains under control at 2.6% in May (Apr: 2.6%), largely due to the government's price control and subsidies.

- Rupiah: Regional currencies, including the Rupiah, relatively weakened against the USD in June. This was largely due to the recent US Fed aggressive 75 bps rate hike decision to tame soaring inflation. As of June 23, the Rupiah depreciated by 4.1% against the USD compared to the end of 2021. This is relatively lower compared to the Malaysian Ringgit (-5.7%), Thai Baht (-6.9%) and Philippine Peso (-7.2%). The depreciation was partially mitigated by Indonesia's strong economic recovery outlook and partly due to a lower current account deficit thanks to robust export earnings amid elevated commodity prices. Going forward, we expect the impact of the hawkish US Fed on the Rupiah to be relatively mild given that the elevated commodity prices would benefit export earnings and boost its current account balance. The Rupiah will also be supported by the rate tightening cycle once BI shifts its tone possibly in the 3Q22.

● Policy rate outlook retained; two rate hikes are expected in 2H22

- We expect BI's policy stance to shift towards a gradual monetary policy tightening once core inflation readings accelerate and breach 3.0% in the coming months. A further weakening of the Rupiah due to the hawkish US Fed may also prompt BI to raise its policy rate to maintain the stability of its local note. For now, it remains clear that BI’s priority is still to support post-pandemic recovery amid heightened external uncertainty.

Source: Kenanga Research - 24 Jun 2022