BI likely to maintain policy rate at 5 pct, keep door open to future rate cuts: Scotiabank

Bank Indonesia (BI) is expected to maintain its policy rate at 5.00 percent on Thursday afternoon, but with the door open to future rate cuts to prop up the nation’s economic growth, according to the latest research report from Scotiabank.

Indonesia’s CPI inflation that slowed to 3.00 percent y/y in November from 3.13 percent y/y the previous month will ease further in December on the back of the base effect, providing scope for more BI monetary easing next year.

Indonesia’s benign inflation outlook will prompt foreign investors to keep pouring funds into local bond markets for higher real returns. According to the BI data, about 38.6 percent of total outstanding Indonesia government bonds are owned by foreign investors.

The IDR has been running a tight correlation with the 10Y Indonesia government bond yield, while remaining vulnerable to capital flight as portfolio investment inflows play a substantial role in financing the nation’s current account deficit and can be withdrawn at a short notice, the report added.

Indonesia sets 2020 gross bonds target at IDR735.52 trillion that is lower than IDR896.59 trillion set for this year, which could alleviate concerns raised by a report that Indonesia's cabinet is discussing relaxing fiscal deficit cap of 3 percent of GDP.

Moreover, Indonesian President Joko "Jokowi" Widodo has urged regional administrations across the country to join the central government’s deregulation push by drafting omnibus bylaws to cut through sprawling regional regulations that have deterred investors.

Implied vols of USD/IDR have been falling since late August amid a steady yuan exchange rate, which is supportive of the socalled carry trade. The phase-one trade deal will defuse prolonged US-China trade tensions, sparking risk appetite further in the holiday season.

Moreover, with the deal including a currency clause, we believe China will stick to its "floating exchange rate system with adjustments and management" and keep the yuan exchange rate basically stable at a reasonable and equilibrium level.

It means the PBoC will allow the yuan to rally if the dollar weakens broadly but will step in to defend the yuan exchange rate if it faces depreciation pressure. Last but not least, the Fed will maintain its dovish stance in the foreseeable future, Scotiabank further noted in the report.

It will likely sustain a risk-friendly mood. Boston Fed President Eric Rosengren said Tuesday he sees no looming reason right now to either cut or raise short-term interest rates any time soon, while Dallas Fed President Robert Kaplan said that he sees little reason to change interest rates in 2020, in a year he expects to bring continued growth and low unemployment.

"We maintain our short USD/IDR position with a target of 13,900 and a stop of 14,300 despite increasing dollar demand near the year-end, while keeping a close eye on the US-China trade headlines till the first week of January 2020 when the 86-page trade agreement is set to be signed by US Trade Representative Robert Lighthizer and his counterpart Chinese Vice Premier Liu He," Scotiabank added in its comments.