The move came after foreign investors sold off Indonesian assets over doubts about the central bank’s ability to keep inflation in check.

BI’s board of governors raised the key rate by 25 basis points to 6.75 percent on Friday, a move widely welcomed by investors and market analysts who had previously considered the central bank “behind the curve” in curbing surging inflation. The key rate had been kept at a record-low 6.5 percent since August 2009.

BI’s rate is used as a reference for banks to adjust lending rates — a monetary tool that indicates a tightening or loosening of the country’s economy. Several emerging markets with high inflation rates have upped their key rates in order to tighten the economy’s expansion.

Stocks, bonds and the rupiah reacted positively to the rate hike, all gaining following the announcement after experiencing losses beforehand. Analysts agreed that BI’s move should substantially restore its credibility and should have a positive effect on markets in the near term.

“The board of governors remained vigilant on inflation expectations that have started to increase. 

The decision [to raise the rate] was made as an anticipatory effort to calm future inflation expectations,” the board said in an official statement.

The board cited soaring and volatile food prices and surging global commodity prices as the main factors contributing to growing inflation expectations. “The board of governors sees that growing inflation expectations need to be responded to with correct measures so as not to result in inflationary pressures in the future.”

Headline inflation peaked at a 21-month high of 7.02 percent in January, mainly due to an 18.25 percent increase in food prices. Meanwhile, core inflation slowed to 4.18 percent and administered prices remained manageable at 5.21 percent.

The Food and Agriculture Organization (FAO)’s latest report showed that world food prices soared to their highest in history in January. BI Deputy Governor Halim Alamsyah said the FAO report was “among the focuses” of Friday’s meeting, seeing risks for inflation tilting toward the upside.

The board “saw the importance of strengthening policy coordination with the government”, as inflationary pressures mainly came from the production and distribution of food and energy commodities.

BI will also strengthen its currency and liquidity measures to tame inflation by letting the rupiah further appreciate and absorbing bank liquidity to limit the money in circulation in order to calm demand-side inflation.

Analysts said the rate hike would not pull down the price of rice, chilies and other foods experiencing soaring prices that have caused inflation, but they agreed that it was a positive signal for the market., especially for the central bank’s credibility.

“Today is a good chapter in BI’s credibility-building history book,” HSBC economist for Indonesia and Thailand Wellian Wiranto said.

Bank Danamon’s Anton Gunawan and Helmi Arman said the rate hike would be effective to “anchor expectations and prevent any dramatic capital outflows or exchange rate depreciations that aggravate the inflation outlook”.

“Today’s rate hike won’t adversely affect the economic growth outlook, given the loose connection between the policy rate and bank lending rates,” the Bank Danamon research team said.

BI cut its policy rate between 2008 and August 2009 to protect the country’s economy from the financial crisis. Since that time, the central bank has persisted in maintaining its key rate at a record low of 6.5 percent until Friday because of worries that higher rates could hamper economic growth.

However, with the recent rate hike, BI still believes the economy could grow by 6.4 percent in the first three months of this year, “backed by strong domestic demands and better export performance”, the board said.

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