Indonesian central bank surprises market with rate hike

Sha Ying | CNBC

Bank Indonesia raised its benchmark interest rate by 25 basis points to 7.25 percent on Thursday. The move comes as a surprise to market participants who widely expected the central bank to keep rates on hold after it raised the benchmark rate by 50 basis points in late August in an attempt to prop up the beleaguered rupiah.

The bank also raised the overnight deposit facility rate, known as the FASBI, by 25 basis point to 5.5 percent.

Thursday's rate hike is the fourth for the Indonesian central bank this year; rates stood at 5.75 percent in January, 150 basis points below their current level. The central bank's hawkish stance is largely aimed at curbing weakness in the rupiah, which has fallen over 16 percent against the U.S. dollar year to date, as well as the country's troubling current account deficit.

Most analysts expected rates to be kept unchanged, Gareth Leather, Asia Economist at Capital Economics said in a note. "After all, [Bank Indonesia] had only hiked rates two weeks ago at an emergency meeting."

"Further ahead, the outlook for monetary policy depends largely on what happens to the currency," he added. "We believe that the current bout of currency volatility is nearing an end and that a prolonged reversal of capital flows is unlikely. As such, we think further aggressive rate hikes in Indonesia will be unnecessary."

However, he cautioned that uncertainty about the timing of eventual policy tightening by the Federal Reserve could trigger further bouts of currency volatility, prompting additional rate hikes in Indonesia.

Not every one believes that this the end of the central bank's tightening cycle. Robert Prior-Wandesforde, Director, Asian Economics at Credit Suisse, expects Bank Indonesia to raise rates again before year end.

"In our view, monetary conditions need to be tightened further and probably will be," he said. "We continue to expect at least one further 25 [basis point] hike in both [the benchmark and FASBI] rates during the fourth quarter of the year, with the timing depending largely on the behavior of the rupiah."

Eight out of 11 analysts in a Reuters survey expected Bank Indonesia to keep its benchmark interest rate on hold.

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