Indonesia's central bank unexpectedly increased its benchmark interest rate by 25 basis points, aiming to support the local currency which has been plummeting towards a historic low.

The surprise move raised the 7-day reverse repo rate from 5.25% to 5.5%. This decision went against the consensus forecast from economists surveyed, who had anticipated the bank would hold rates steady.

The rate hike comes against a backdrop of sustained foreign capital outflows from Indonesian equities and a slide in the rupiah's exchange rate against the US dollar to near-record lows. The central bank identified large-scale outflows of foreign portfolio investment as the primary driver behind the rupiah's persistent depreciation.

To support the currency, the central bank had already delivered an unexpected 50-basis-point hike at its May meeting and has been actively intervening in the foreign exchange market. However, these measures have had limited effect. Despite deploying significant foreign exchange reserves to stabilize the rupiah, the currency hit a new all-time low of 18,190 per US dollar on June 8. Year-to-date, the rupiah has depreciated by more than 8% against the dollar, and Indonesia's foreign reserves have fallen to their lowest level in nearly two years.

The central bank stated that the latest rate increase serves a dual purpose: to buffer against external shocks from geopolitical conflicts in the Middle East and as a preemptive policy step to ensure domestic inflation remains within the government's target range of 1.5% to 3.5% for 2026 and 2027.

The bank's statement added, "This rate hike is also intended to enhance asset yields and attract inflows of foreign portfolio investment into Indonesia."

The decision was announced as domestic inflation shows signs of a gradual uptick. The latest inflation data for May came in at 3.08%, higher than April's 2.42% and exceeding market expectations of 2.97%.

Last week, Indonesia's parliament granted the central bank a new policy mandate to foster an economic environment conducive to real economic growth and job creation. However, analysis from DBS Group Research suggested that despite this new objective, "monetary policy will likely prioritize financial market stability in the near term and may continue tightening to defend the currency."

Following the rate announcement, the rupiah strengthened by 0.66% against the US dollar on Tuesday, trading at 18,050.