Indonesia's central bank raised its benchmark interest rate by 25 basis points to 6.75 percent on Friday, citing growing inflationary pressures and surprising many in the market who had expected it to keep borrowing costs at a record low.
Eight of 15 economists polled by Reuters earlier had expected no change — even after inflation raced to a 21-month high of 7.02 percent in January — but all were positive about the move, saying it was about time the central bank started tackling price pressures that have spooked foreign investors.
The rate increase was the first for Indonesia in nearly two years, leaving the Philippines as the only large Asian economy to have kept rates unchanged since the end of the global financial crisis.
Worries that Bank Indonesia was falling behind the curve in fighting price pressures had sparked a selloff in Indonesia stocks and bonds in January, though markets have appeared to stabilize in the last few weeks.
Bank Indonesia deputy governor Halim Alamsyah, waylaid by reporters after emerging from Friday prayers, said policymakers decided to raise the key rate because of concerns about the effect that rising food prices were having on broader inflation.
"BI wants to give a clear signal to the market. It wants to assure markets that it is being proactive and that it is not behind the curve," said Eric Sugandi, an economist with Standard Chartered.
Most economists expect the bank to raise the key rate by a further 75 basis points over the course of 2011 as it normalizes monetary policy.
"Most investors would take that very positively," said Prakriti Sofat, an economist with Barclays Capital in Singapore.
"Any concern on inflation or selloff will be pretty small," she said. "I expect the central bank to hike the rate to 7.5 percent within 4 to 5 months."
A 16 percent annual jump in raw food prices in January drove headline inflation higher than expected and further above the central bank's end-year 4-6 percent target.
But the bank said on Friday it was confident that inflation could be held at the original targets.
The contrast between headline and core inflation has been complicating Bank Indonesia's decision making, as it has always maintained it wanted to use a rate hike as a policy of last resort to avoid crimping buoyant bank lending or attracting even greater capital inflows.
The central bank has also been intervening in the foreign exchange market to stem inflation, targeting 9,000 rupiah per dollar as a benchmark to achieve its inflation target.
On Friday the rupiah strengthened to 8,995 after the rate hike from 9,025, while the main stock index pared early losses to close up 0.44 percent.
Bank Indonesia had held rates at a record low of 6.5 percent for 18 months, first on worries that higher rates could choke economic growth and later on concerns that rise rises would attract even more foreign capital flows into the country, potentially destabilizing the economy.
Those concerns had led them to opt for other monetary measures to curb inflation.
The central bank has unwound stimulus measures taken during the 2008 financial crisis to absorb excess liquidity in the financial system that can build up core inflation.
It announced last month it would raise the minimum dollar reserve requirement for commercial banks and limit their short-term foreign borrowings.
Bank Indonesia had cut its policy rate by a total of 3 percentage points between December 2008 and August 2009 to shield the economy from the financial crisis, and had left it at 6.5 percent until Friday.
In its last battle with high food and fuel prices in 2008, inflation topped 12 percent and it was forced to raise rates to as high as 9.5 percent even as the global financial crisis intensified and other central banks were slashing borrowing costs.
In 2005-2006, inflation raced up to more than 18 percent and BI hiked rates from 8.5 percent to 12.75 percent in just six months.
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