Fourth consecutive months of deflation
According to Statistics Indonesia (BPS), the monthly inflation rate decreased to -0.03% MoM in Aug-24, marking the fourth consecutive month of deflation. This rate slightly surpassed both our expectations and the consensus forecasts of -0.10% MoM and -0.04% MoM, respectively. The slowdown was primarily driven by higher food stock levels, leading to a -0.52% MoM deflation in the food, beverages, and tobacco basket, which contributed -0.15% to the headline inflation rate. Conversely, the education basket emerged as the biggest contributor to inflation, rising by 0.65% MoM and contributing 0.04% to the overall inflation rate, driven by the new academic year. Furthermore, Volatile food prices continued their deflationary trend for the fifth consecutive month, falling by -1.24% MoM in Aug-24. On the other hand, administered prices accelerated to 0.23% MoM, reaching their highest level since April, driven by a hike in non-subsidized fuel prices. Meanwhile, core inflation rose by 0.20% MoM in Aug-24, also reaching its highest level since April, mainly driven by education hike. Looking ahead, volatile food prices are expected to decrease further, driven by a weak La Niña and the planting areas expansion program. Additionally, Minister of Agriculture projects a 10% YoY increase in Indonesia's agricultural production for 2024. However, the upcoming restrictions on subsidized fuel, set to take effect in Oct-24, could potentially trigger a rise in inflation.
Yearly inflation drops to its lowest level since Feb-22
The annual inflation rate slightly eased to 2.12% YoY in Aug-24, continuing the downward trend since March and reaching its lowest level since Feb-22. This figure is closely aligned with both our estimate of 2.06% YoY and the consensus forecast of 2.11% YoY. Furthermore, it remains within Bank Indonesia's target range of 1.5% to 3.5% YoY. Notably, the food, beverage, and tobacco basket were the largest contributor to the inflation rate at 0.96% YoY. However, price growth in this basket slowed to 3.39% YoY in Aug-24, down from 3.66% YoY in the previous month. Meanwhile, volatile food inflation decreased to 3.04% YoY in Aug-24, compared to 3.63% YoY in Jul-24, driven by a drop in foodstuff prices to 2.76% YoY in Aug-24 from 3.25% YoY in Jul-24. On the other hand, administered prices increased to 1.68% YoY in Aug-24 from 1.47% YoY in Jul-24. Core inflation also accelerated to 2.02% YoY, up from 1.95% YoY in the previous month, aligning with our estimate and the consensus estimate of 2.01% YoY and 2.00% YoY, respectively. Although annual inflation continues its downward trend, we expect the inflation rate to potentially rise for the remainder of this year. This potential increase could be driven by factors such as restrictions on subsidized fuel, local elections, a BI rate cut, and Christmas festivities. Currently, we project the inflation rate to reach 2.80% YoY by the end of 2024.
Weak La Nina and restriction to subsidized fuel ahead
We expect that volatile food prices may ease due to increased agricultural productivity. However, there is a potential rise in administered prices as a result of restrictions on subsidized fuel. Furthermore, Minister of Agriculture is optimistic that agricultural production could increase by 10% YoY in 2024, driven by the weak La Niña phenomenon and the expansion of planting areas program. According to the Meteorology, Climatology, and Geophysics Agency (BMKG), a weak La Niña is expected to begin in late August-October 2024, likely enhancing water availability for irrigation. BPS also projects that domestic rice production during this weak La Niña period (August-October 2024) could reach 8.42 mn tons, marking the highest production during this period in the last decade. Additionally, the planting area expansion program, which includes initiatives like water pumping for rain-fed lands, optimizing swamp land, and intercropping rice with oil palms, is expected to further boost agricultural productivity. On the other hand, the government is set to introduce new regulations this week to restrict access to subsidized fuel, limiting it to certain vehicles. The Minister of Energy and Mineral Resources has stated that this regulation will take effect on October 1, 2024. While this regulation could help the state budget deficit by reducing subsidy expenditures, it also carries the risk of triggering an increase in inflation. The government need to closely monitor its implementation to prevent illegal fuel sales.
Anticipating BI's rate cut following the Fed's dovish turn
Bank Indonesia (BI) has decided to keep its benchmark interest rate at 6.25%, aligning with both our expectations and market consensus. This marks the fourth consecutive month of maintaining this rate. The deposit and lending facility rates remain steady at 5.50% and 7.00%, respectively. This decision supports BI's objectives to keep inflation within the target range of 2.5% ±1% for 2024 and 2025, stabilize the rupiah, and attract foreign capital inflows. The rupiah has appreciated by 4.96% MoM to Rp15,455/USD in Aug-24. BI will continue to implement pro-growth macroprudential and payment system policies to support sustainable economic growth. We anticipate that BI will lower its benchmark rate by 25 bps to 6.00% in 4Q24, following an expected rate cut by the Federal Reserve (Fed). Lowering the BI rate before the Fed's could risk triggering capital outflows. The Fed has recently adopted a more dovish stance, with US inflation dropping to 2.9% YoY in Jul-24, down from 3.0% the previous month, and the unemployment rate rising to 4.3% in Jul-24, up from 4.1% in Jun-24. We also expect the Fed to cut its rate by 25 bps in both September and November, bringing it to 4.75% in year end 2024.
