Indonesia's inflation pegged to hit 9-9.8%

Rupiah continues to weaken.

According to Bank of America Merrill Lynch, Bank of Indonesia is now expecting inflation to come in around 9%-9.8% at end of the year, largely driven from “volatile food and administered prices”, much higher than earlier guidance (in July) of 7.2%-7.8%.

Meanwhile, analyst expects inflation to peak at around +10 to +10.5% in Dec/Jan. We raise our full year average inflation forecast to +7.5% (from +7.2%) in 2013, and our 2014 inflation forecast to +6.7% (from +6.5%).

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A weakening rupiah will put further upside pressure on inflation, via higher import prices and possible price adjustments from local firms. The rupiah has declined by about 15% against the greenback so far this year, and has breached a critical Rp10,000 threshold (now at about Rp11,220). 

We see a potential pass-through of about 15% from a weaker currency to inflation.

We also see the risk of rising global oil prices, especially with the ongoing Syria conflict. Our Global Commodities team estimates that Brent crude oil prices could be pushed to US$120-130/bbl (from $115.7/bbl currently) in the event of Syrian strikes.

By our estimates, a +10% increase in oil prices could potentially add +40bps to headline inflation.

Furthermore, we are also mindful of the risk of a "wage-price" spiral, given ongoing labor negotiations for minimum wages to be increased in early 2014.

The government plans to cap the increase of minimum regional wages to a maximum of 10% above inflation, according to Manpower Minister Muhaimin Iskandar. That could imply a wage hike of close to +20% early next year.