BI holds benchmark rate steady; Indonesian Rupiah weakens

Bank Indonesia's rate decision leaves the Indonesian Rupiah under pressure, supporting USD/IDR.
5.75% remains BI's benchmark rate, defying expectations of an increase to 6.0%.
83.9% is the market-implied probability of a rate hold next week, according to the FedWatch Tool.

18,040 is the approximate USD/IDR level during Wednesday's European session. The pair is advancing for a third consecutive day as the Indonesian Rupiah (IDR) comes under pressure following Bank Indonesia's (BI) policy decision. BI left its benchmark rate at 5.75% for a fourth consecutive meeting, contrary to market expectations of an increase to 6.0%. Its overnight deposit rate was raised by 25 bps to 5.00%, while lending facility rates remained at 6.50%.

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Safe-haven demand for the US Dollar (USD) is also lifting USD/IDR as higher oil prices intensify concerns over global inflation. Crude prices are climbing while traders assess conflicting signals on diplomatic contacts between the United States (US) and Iran. Negotiations are still under way, but sentiment came under pressure after high-level meetings in Tehran. Pakistan’s army chief, Field Marshal Asim Munir, met senior Iranian diplomatic and military leaders there to discuss bilateral relations and the progress of talks with Washington. According to a diplomat involved in the discussions, efforts to resolve the conflict continue, but reports suggesting a final agreement is imminent are premature.

An 83.9% probability of unchanged Federal Reserve (Fed) interest rates next week is priced in by traders, according to the CME FedWatch Tool. Markets also assign a 90% chance to a December rate increase as they assess the Fed's next steps. Fed Chair Kevin Warsh, however, remained neutral. Stressing that he does not "prejudge" interest rate decisions, he gave markets no firm indication of whether the central bank would increase rates or leave them unchanged at its forthcoming October policy meeting.

Interest rates: key questions

Interest rates explained

For borrowers, interest rates determine the charges financial institutions apply to loans; for savers and depositors, they determine the interest paid. Base lending rates influence these rates. Central banks set base rates in response to economic developments and generally operate under a price-stability mandate. In most cases, that means aiming for core inflation of around 2%. When inflation is below target, a central bank may reduce base lending rates to encourage lending and support economic activity. Inflation substantially above 2%, by contrast, normally prompts an increase in base lending rates to bring price growth down.

Interest rates and currency strength

By making a country more attractive to international investors seeking a home for their funds, higher interest rates generally support its currency.

Interest rates and Gold prices

Holding Gold rather than an interest-bearing investment or a bank deposit carries a greater opportunity cost when interest rates rise. Higher rates therefore generally put downward pressure on Gold prices. High interest rates also tend to strengthen the US Dollar (USD). Because Gold is priced in Dollars, this typically lowers its price.

The Fed funds rate explained

US banks lend to one another overnight at the Fed funds rate. This widely cited headline rate is set by the Federal Reserve at its FOMC meetings. Although expressed as a range, such as 4.75%-5.00%, the figure usually quoted is its upper bound, or 5.00% in that example. The CME FedWatch tool tracks market expectations for the future Fed funds rate. Those expectations influence behaviour across many financial markets ahead of Federal Reserve monetary policy decisions.