Bank Indonesia left the key rate unchanged at 5.5% on Wednesday, along our expectations, after a rate cut last month. Despite a benign inflation outlook, policymakers likely viewed the recent Middle east tensions and its impact on the regional currencies, with trepidation. There is further speculation that the US might join the Israeli forces, potentially widening the scope of attack on Iran. Oil prices are off their back, with the risk of hurting emerging markets with high energy import bills. The US Fed paused on rates in its overnight decision, whilst new projections point to a divide amongst the policymakers on the direction for the year. Steady US rates and geopolitical risks might provide a brief respite to the greenback, limiting the room for further rupiah appreciation. After a temporary pause in June, we expect BI to stay opportunistic on the timing of the next move, with the door open for another 50bp cuts this year to a terminal rate of 5%. Official bond purchases are likely to limit yields’ upmove, while bouts of rupiah depreciation draw in the central bank’s hand.
The BSP meets to decide on rates on Thursday and we expect a 25bp to 5.25%, which would take cumulative cuts to 125bp in this cycle. This is unlikely to be an easy decision, considering peso’s recent underperformance, concurrent to a lift in oil prices. The PHP slipped to a two-month low this month, depreciating ~2% against the dollar and is one of the regional underperformers this year. Preferring to preserve their FX reserve stock, Governor Remolona said it was futile to intervene strongly in the face of weak risk sentiments benefiting the dollar. Focus, instead, is likely to be on domestic considerations, which lay the ground for further rate reductions. With inflation rising by the slowest pace in six years of 1.3% yoy in May, real rate buffer is significant. Add to this, incoming activity-based indicators have been mixed besides the overhang of global uncertainties. This is likely to strengthen the case to lower rates further this quarter, followed up by another likely rate cut in 3Q, which will take the rate to a neutral level of 5% this year.
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