Policy, inflation doubts halt Indonesia bonds rally

By Vidya Ranganathan

SINGAPORE, Aug 6 (Reuters) - Indonesian government bonds appear to have run into some resistance after a surprising rally that lasted nearly two months and occurred despite rising policy rates and accelerating inflation.

Bond prices at the longer end of the yield curve had risen since June, boosted by the abundance of cash in the banking system and strong belief that, unlike in 2005, the authorities had a firm grip on inflationary pressures and policy.

Five-year bond yields hit 10.9 percent on Wednesday, down from 13.4 percent in early June, as bond prices soared.

But the steepness of the rally and persistent inflation have sowed some doubts in investors' minds, and put a floor under yields. At least a couple of analysts had been expecting 5-year yields to hit 11 percent only by the year end.

"People have been buying into Indonesia on the expectation that this inflation shock, similarly to Korea, will work its way through the system and pop out the other side. That inflation will come off," says Peter Redward, head of Asian rates strategy at Barclays Bank.

"We are pretty sceptical of that view in Indonesia," he said.

Redward reckons that strong economic and credit growth will exert upward pressure on inflation for longer. Moreover, the full impact of the surge in global commodity prices had not yet been passed on to Indonesian consumers.

Even those who are bullish Indonesian bonds doubt five-year yields could fall far below 11 percent.