The BI board of governors decided on Thursday to lift the benchmark seven-day reverse repo rate (7DRRR) by 50 bps to 4.25 percent, a figure last seen in June 2020, while the lending and deposit facility rates went up 25 bps to 5.00 and 3.50 percent, respectively.

Economists from state-owned Bank Mandiri and financial research firm Moody's Analytics had expected the rates to rise by just 25 bps, as had those polled by Reuters.

BI Governor Perry Warjiyo said more aggressive interest rate hikes were “not needed” in Indonesia as the country had managed second-round impacts on core inflation better than other countries.

"The decision to raise interest rates is a front-loaded, pre-emptive and forward-looking measure to lower inflation expectations and ensure that core inflation returns to the target of 3 plus or minus 1 percent in the second half of 2023," Perry said at a press conference after the board's monthly two-day monetary meeting ended on Thursday.

Read also: BI hikes rate for first time since 2018, warns inflation could exceed 5%

BI said the front-loading strategy was necessary to anticipate rising inflation expectations and rein in second-round impacts from price hikes, noting that it took time for interest rates to impact inflation.

Perry expressed hope that the 50 bps hike would bring the rupiah’s exchange rate to its “fundamental value”, as Indonesia currently had a “very low current account deficit” and “a very good balance of payments”.

Data from Bank Mandiri shows that the rupiah has depreciated 5.2 percent against the greenback so far this year to trade at Rp 14,998 per US dollar on Thursday.

“The exchange rate should have strengthened, [given the] strong domestic demand growth [in Indonesia] amid high uncertainty in global financial markets,” Perry continued.

The Fed raised interest rates by 0.75 percentage points on Wednesday for the third time in a row and suggested further significant increases were inevitable.

“We have got to get inflation behind us. I wish there were a painless way to do that. There isn’t,” Fed chair Jerome Powell said at a news conference.

Read also: Indonesia to raise rates by another 25 basis points in September: Reuters pol

BI estimated that despite the countermeasures taken, inflation pressure would remain high as the recent fuel price hikes and the government’s social assistance would reverberate in the next three months.

Headline inflation is expected to rise to 5.89 percent year-on-year in September, with full-year 2022 inflation seen at “a little more than” 6 percent.

Year-end core inflation, the prime target of BI’s monetary strategy, is expected to rise to 4.6 percent yoy, but the rate is predicted to come back down to the target range of 2 to 4 percent in the second half of 2023.

Finance Minister Sri Mulyani said on Thursday that the Fed’s decision to raise interest rates by 75 bps had been expected but required caution.

“We should keep our guard up for potential capital outflow turmoil due to a very hawkish interest rate hike,” the finance chief told reporters.

Bank Mandiri economists had predicted that BI would raise the key policy rate to a maximum of 4.25 percent by the end of the year. After Thursday’s BI decision, they raised that estimate to 5 percent by the end of the year and 5.25 percent in 2023.

This policy was needed to mitigate the risk of capital outflow from Indonesia, particularly in the sovereign debt papers market, as the trade surplus was expected to shrink amid a slowdown in global growth.

“The target can be achieved, as long as no more adjustments are made to energy prices while food prices are maintained,” Mandiri economist Faisal Rachman told The Jakarta Post on Thursday regarding the central bank’s target for core inflation in 2023.

University of Indonesia economist Fithra Faisal Hastiadi, meanwhile, said he expected September headline inflation to be 5.66 percent and warned of the impact of high inflation expectations.

With the recent rate "shock" by BI, he said, which was likely to be followed by two more increases of 25 bps each, year-end inflation could be kept below 8 percent, though it would probably be above 7 percent.

“Reactive policies cost much more than anticipatory policies,” Fithra told the Post on Thursday.