UPDATE 1-Indonesia Sept inflation slows, rate seen on hold

(Refiles to add dropped word "rates" in first paragraph)

By Aditya Suharmoko

JAKARTA Oct 3 (Reuters) - Indonesia's inflation slowed in September as food prices eased after the Muslim festive season, but policymakers are walking a tightrope as they try to balance their desire to cut interest rates against pressures to stabilise financial markets.

Complicating the policy outlook in Southeast Asia's biggest economy is the risk of higher food inflation from next year when Indonesia and other rice importers face a rise in prices from Thailand, the world's biggest rice exporter, following a new Thai rice-price guarantee scheme imposed this month.

Annual inflation in September was 4.6 percent, below 4.79 percent in August and less than the 4.80 percent expected by most economists surveyed by Reuters, data from the country's statistics bureau showed on Monday, cementing expectations that the central bank will hold the benchmark interest rate steady next week amid global uncertainty.

Indonesia is enjoying an economic boom, with growth of more than 6.5 percent, rising consumer spending, swelling incomes and a newly minted status as a middle-income country, with per capita GDP passing $3,000 this year.

But sustaining that, and keeping inflation in check, looks increasingly difficult in the face of volatile global markets. More than a year of heavy foreign buying of stocks and bonds has made Indonesia vulnerable to outflows that have accelerated in recent weeks as those investors pull their money out.

"We doubt that the central bank will react much to this latest inflation read, especially at times when the market still looks somewhat unstable," said Gundy Cahyadi, an economist at OCBC Bank in Singapore.

The statistics bureau said that despite slower overall inflation, some prices were still high, such as the cost of chilli, along with gold jewellery and cigarettes due to a government plan to raise tobacco taxes.

Core inflation -- which excludes administered prices and volatile foods -- eased to 4.93 percent from 5.2 percent a month earlier, near the 5 percent level a central bank official said could trigger policy tightening. That was largely in line with the 4.96 percent expected on average by economists.

However, volatile global conditions have shifted Bank Indonesia's stance from fighting inflation to boosting growth, and officials have indicated they might consider cutting rates.

The next central bank meeting on rates is on Oct. 11.

BOND BUY-BACKS

In August, core inflation reached a two-year high of 5.15 percent, reflecting how the pace accelerates as Muslims shop heavily for the important Eid holidays at the end of the Ramadan fasting month.

Bank Indonesia last month left its benchmark policy rate steady at 6.75 percent for a seventh straight month, but lowered the floor of its interbank overnight rates, seen by some analysts as a form of policy easing.

Still, most analysts remain of the view BI will hold the rate for the rest of this year, making Indonesian government bonds more attractive at a time investors are worried about putting money in riskier assets.

In recent weeks, volatile Indonesian markets due to euro zone worries have prompted authorities to pursue unusual measures from buying back bonds to telling state insurers and banks not to sell government bonds in an attempt to stabilise prices.

BI made a surprise 25 basis points rate rise in February aimed to market worries that Indonesia was not doing enough to combat inflation. Since then, inflation has been under control since, and a BI official forecast inflation would be below 5 percent by year-end, within its target range of 4 to 6 percent.

At present, the main concern for BI and other emerging market central banks now is to support growth, leaving their fight against inflation a lower priority as the global outlook deteriorates.

The central bank sees the Indonesian economy expanding 6.6 percent this year, but its governor said in early September the GDP rise next year could be lower than a 6.7 percent government target due to global risks.

The rupiah, which strengthened during the first eight months of the year, fell about three percent against the dollar during September. (Additional reporting by Adriana Nina Kusuma. Editing by Jason Szep)