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conomists warn that Bank Indonesia'€™s (BI) key interest rate, which currently stands at 7 percent, a four-year high, may have to rise again due to inflationary pressures as well as increased volatility of the rupiah in the coming weeks.

Governor Agus Martowardojo jacked up the BI rate earlier this week by 50 basis points to 7 percent.

The latest rise in the BI rate amounted to a cumulative 125-basis point increase since the 57-year-old Agus took office in May, as the central bank '€” known for its pro-growth stance '€” has switched to a hawkish mode to maintain economic stability.

For now, the central bank'€™s bold interest rate hike seemed to boost the rupiah and helped calm restive markets.

On Friday, the rupiah strengthened for the second consecutive day, advancing 0.1 percent to touch 10,920 per US dollar, according to Bloomberg.

The Jakarta Composite Index (JCI) recovered from its 13-month low, climbing 2.2 percent to 4,195.09, while the yield on 10-year government bonds dropped 24 basis points to 8.48 percent.

But volatility in the financial markets may heat up on Monday, when the Central Statistics Agency is scheduled to announce the inflation figures for the month of August.

BI has previously forecast monthly inflation in August of higher than 1 percent, with annual inflation predicted in the range of 9 percent to 9.8 percent by year'€™s end.

Senior BI officials would convene their monthly board of governors'€™ meeting on Sept. 12, with an additional rate increase '€œlikely'€ to happen amid annual headline inflation that was moving closer to 10 percent, predicted Santitarn Sathiratai, an economist with Credit Suisse.

Headline inflation, however, may not give an accurate picture of the behavior of an economy because it also takes into account changes in food and energy prices, which can often be volatile.

Echoing Sathiratai, Ho Woei Chen, an economist with the United Overseas Bank (UOB) in Singapore, said BI was now under '€œimmense pressure to continue raising interest rates'€ due to soaring inflation.

A further increase in the BI rate may also be necessary to safeguard the rupiah against the risk of more severe capital outflows in anticipation of a possible tapering of the US monetary stimulus,
economists agree.

Top officials from the Federal Reserve (the Fed) '€” the US'€™ central bank '€” are slated to hold a meeting on Sept. 17 to discuss the fate of the stimulus, which is popularly known as quantitative easing.

The rupiah has plummeted 5.9 percent this month '€” the biggest drop since November 2008 '€” mainly due to huge capital outflows sparked by the release of the minutes of the Fed'€™s latest meeting, which said that officials with the US central bank were '€œcomfortable'€ with the plan to start unwinding the quantitative easing policy next month.

'€œThere may still be a chance of another rise in the BI rate if market pressure intensifies once the Fed starts to taper off the stimulus,'€ Bank Danamon economists Dian Ayu Yustina and Anton Gunawan wrote in a research note.

However, it could be problematical for BI officials to further raise the key interest rate.

While a higher BI rate that lured more foreign inflows would support the rupiah, on the other hand it could also lead to a slow-down in investment causing a deceleration in growth as banks would be forced to pass on higher interest rates to those companies looking to expand their businesses.

For every 100-basis point hike in the BI rate, Indonesia will likely see a 0.2 percent deceleration in its economic growth in the next six to 12 months, according to calculations from economic researchers with state-run Mandiri Sekuritas.

'€œWe expect to see a slow-down in economic activity,'€ Mandiri Sekuritas economist Aldian Taloputra said.

'€œA higher interest rate will eventually result in tighter liquidity,'€ he added.

He predicted that the economy would expand by only 5.8 percent this year, well below the government'€™s assumption of 6.3 percent as stipulated in the revised 2013 State Budget.