Higher than our (0.78 percent) and consensus (0.73 percent) estimates, Indonesia'€™s July inflation rose 0.93 percent, driven by volatile components, +2.13 percent month-on-month (mm), +8.97 percent year-on-year (yoy), especially the transportation sector, +1.74 percent mm, +8.67 percent yoy.

The deviation from our expectation was a consequence of the higher-than-expected impact of Idul Fitri on transportation inflation and staple food prices. Additionally, a 1.6 percent increase in the non-subsidized electricity price further pressured administered prices, which rose 1.67 percent mm (June: 0.23 percent mm). In a year-to-date perspective, we calculate 1.9 percent inflation (2.9 percent during January to July, last year).

July'€™s core inflation rose 0.34 percent mm but fell to 4.86 percent yoy (June: 0.26 percent mm, 5.04 percent yoy) as inflation dropped to 0.51 percent mm for processed foods and to 0.13 percent mm for housing. Interestingly, core inflation for the month directly following Idul Fitri this year was the lowest since 2011 (Table 1), confirming a muted aggregate demand level and a negative output gap level in the second quarter, this year (Q2 2015).

Without supply shocks, inflation should normalize toward Bank Indonesia'€™s target of 4 percent +/- 1 percent in the fiscal year 2015 with another round of fuel-price hikes and El Niño still the most significant threats until year end. While Energy and Mineral Resources Minister Sudirman Said stated that fuel prices would be unchanged in August, it is possible that a Sept.-Oct. hike may occur.

At this stage, we expect normal economic adjustments to bring the August consumer price index (CPI) to 0.62 percent mm, supported by demand normalization in transportation and staples. On the supply side, if the regular gasoline price were to rise in September by a typical 15 percent to Rp 8,500/liter, we estimate headline inflation would rise to around 1.0 percent mm. The pass-through impact would be less than that in the 2013 and 2014 fuel-price hikes, as weak purchasing power is already limiting cost-push inflation effects (Table 2). We are confident that 2015 inflation will remain within BI'€™s target.

BI Governor Agus Martowardojo stated on Aug. 3 that, even though inflation is expected to soften, BI would be less likely to change its monetary policy stance due to uncertain global factors. This is in line with our expectation as July capital outflows and the recent swift rupiah depreciation should limit room for BI to cut the benchmark rate, in our view.

Nevertheless, with the Q2 2015 gross domestic product (GDP) release Wednesday at 4.67 percent (Bahana: 4.66 percent), slightly below Q1 2015'€™s level, the central bank could be under pressure to lower interest rates ahead to jumpstart the economy. At this stage, the market will now await the current account deficit (CAD), (Bahana: 2.5 percent of GDP), due out on Aug. 14. In our view, further pressure for BI to lower its benchmark rate will arise if the CAD turns out to be lower than expected.
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The writer is an analyst at Bahana Securities.

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