BI’s decision to hold benchmark rate steady weighs on Indonesian Rupiah

Weakness in the Indonesian Rupiah following Bank Indonesia’s rate decision lends support to USD/IDR.
Despite expectations of a hike to 6.0%, BI left its benchmark rate unchanged at 5.75%.
An 83.9% probability of rates remaining unchanged next week is priced into markets, according to the FedWatch Tool.

USD/IDR’s rally continues for a third consecutive day, with the pair trading near 18,040 in Wednesday’s European session as the Indonesian Rupiah (IDR) remains under pressure. The Rupiah’s weakness follows Bank Indonesia’s (BI) decision to retain its benchmark rate at 5.75% for a fourth consecutive policy meeting, contrary to market expectations of an increase to 6.0%. While the central bank raised its overnight deposit rate by 25 bps to 5.00%, it left lending facility rates 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 advancing while traders assess conflicting signals on diplomatic engagement 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, held discussions with senior Iranian diplomatic and military leaders on 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.

The Federal Reserve’s (Fed) next policy steps remain a key focus for financial markets. Pricing tracked by the CME FedWatch Tool puts the probability of unchanged rates next week at 83.9%, while assigning a 90% chance to a rate increase in December. Fed Chair Kevin Warsh, however, remained neutral, stressing that he does not "prejudge" interest rate decisions. His comments offered no clear indication of whether the central bank would raise rates or leave them unchanged at its forthcoming October policy meeting.

Interest rates: key questions answered

How do interest rates work?

For borrowers, interest rates determine the charges financial institutions levy on loans; for savers and depositors, they determine the interest received. These rates respond to base lending rates, which central banks set as economic conditions change. Maintaining price stability is usually part of a central bank’s mandate, generally through a core inflation target of around 2%. When inflation slips below target, a central bank may lower base lending rates to encourage borrowing and support economic activity. Conversely, inflation substantially above 2% usually prompts an increase in base lending rates aimed at bringing price pressures down.

Why do interest rates affect currency values?

A country’s currency typically benefits from higher interest rates, as the country becomes a more appealing destination for global investors’ funds.

Why can higher interest rates weigh on Gold prices?

Gold prices generally face pressure when interest rates rise. Higher rates increase the opportunity cost of holding Gold rather than buying an interest-bearing asset or keeping money in a bank. High interest rates also tend to strengthen the US Dollar (USD). As Gold is priced in Dollars, this typically pushes its price lower.

How is the Fed Funds rate determined?

US banks lend to one another overnight at the Fed funds rate, the widely cited headline rate that the Federal Reserve sets at its FOMC meetings. Rather than a single figure, it is expressed as a range, such as 4.75%-5.00%. The figure commonly quoted is the upper bound, which in this example is 5.00%. The CME FedWatch tool tracks market expectations for the future Fed funds rate. Those expectations influence behaviour across many financial markets as participants anticipate the Federal Reserve’s forthcoming monetary policy decisions.