SCENARIOS-Indonesia's central bank policy outcomes

JAKARTA, Sept 2 - Indonesia's central bank is expected to hold its overnight policy rate <BIPG> at a record low on Thursday given that price pressures appear likely to pick up, confirming that an easing cycle that began in December is over.

All 10 analysts surveyed by Reuters predicted the central bank would hold its policy rate at 6.50 percent and the focus will be on comments on the inflation and growth outlook that will provide markets with more clues about policy in months ahead.

Nine out of 10 forecast the policy rate would be held steady this year, and four said they expected the central bank to start its tightening cycle in the first quarter of 2010. It last cut rates by 25 basis points to 6.5 percent in August, having cut rates by a total of 300 basis points since December. [ID:nJAK536367]

Here are some possible outcomes of Bank Indonesia's policy meeting.

FOCUSES ON PRICE PRESSURES AHEAD, CONFIRMS END OF EASING CYCLE This is the most likely outcome, with the central bank using the pick up in prices since the start of the Ramadan fasting month to highlight rising price pressures. It is also likely to repeat its warning that higher international commodity prices may add to inflation pressures next year.

The central bank is also expected to shift its focus on core inflation, which excludes volatile food and controlled prices. Annual core inflation eased to 4.84 percent in August from 4.91 percent in July, but was still over 2 percentage points higher than the headline figure.

Food prices have picked up in the world's most populous Muslim country in the run-up to Ramadan, which started on Aug. 22 and the festivities that mark the end of the fasting month, on Sept. 21-22. While the spike is largely seasonal, the central bank watches the performance of prices during the period as an indication of possible bottlenecks in supply and distribution of goods, which are key factors in predicting inflation in the vast archipelago.

The central bank is also under less political pressure to ease rates further and spur economic growth following an important interest rate agreement with the country's major commercial banks in late August.

Under that deal, the commercial banks -- which have been very slow to pass on interest rate cuts to borrowers -- agreed to lower their maximum deposit rates to 8 percent, or 150 basis points above the current policy rate, from more than 10 percent previously. [ID:nJAK530890]

Government bonds are likely to show little reaction under such a scenario because the debt market has already factored in the end of monetary easing, with the yield of the benchmark five-year bond <IDFR0051=> likely to hover near the current level of 9.5 percent. [ID:nJAK389904]

BANK INDONESIA SIGNALS FURTHER RATE CUTS

This is considered very unlikely given a rise in inflation in August, although one analyst polled by Reuters considers this a possible outcome. Annual inflation inched up to 2.75 percent in August from 2.71 percent in July, defying market expectations it would dip to 2.66 percent. [ID:nJAK363892]

Expectations that inflation will still undershoot the central bank's 5-7 percent year-end forecast and the strength of the rupiah <IDR=>, which so far has gained 8 percent this year, may argue there is still room for some monetary easing.

Central bank comments that will highlight the rupiah's strength and its tempering effect on import prices may be taken as a signal that it still sees some scope for a rate cut.

A clear signal from acting governor Darmin Nasution, who took office in July and is seen as a monetary dove [ID:nJAK298514] could lift bonds somewhat, but the upside would probably be limited due to expectations of a gradual build up in price pressures.

The belly of the curve may benefit the most, as this is the section that suffered the most in August on anticipation that the government would issue more medium-tenor paper and firming expectations that rates will remain on hold for the rest of the year.

CENTRAL BANK ISSUES INFLATION WARNING, SIGNALS HIGHER RATES

The central bank may prompt analysts to bring forward their rate rise expectations by warning that inflation may vault above its 5 percent target next year and stressing the risk from raises in government-controlled prices. However, analysts doubt the central bank would issue such a warning at a time when inflation still remains benign. In such an unlikely case, government bond prices would fall further.