The Bank of Russia cuts the key rate by 25 bp to 7.00% per annum

On 6 September 2019, the Bank of Russia Board of Directors decided to cut the key rate by 25 bp to 7.00% per annum. Inflation slowdown is continuing. At the same time, inflation expectations remain elevated. The Russian economy’s growth rate is still coming in lower than the Bank of Russia’s expectations. Risks of a global economic slowdown have increased. Risks of inflation accelerating or slowing down by the year-end are balanced. In these circumstances and taking actual inflation dynamics into account, the Bank of Russia has lowered its end-of-year annual inflation forecast for 2019 from 4.2-4.7% to 4.0-4.5%. Moving on, according to the Bank of Russia’s forecast and taking into account the monetary policy stance, annual inflation will remain close to 4%.

If the situation develops in line with the baseline forecast, the Bank of Russia will consider the necessity of further key rate reduction at one of the upcoming Board of Directors’ meetings. In its key rate decision-making, the Bank of Russia will take into account actual and expected inflation dynamics relative to the target and economic developments over the forecast horizon, as well as risks posed by domestic and external conditions and the reaction of financial markets.

Inflation dynamics. Inflation slowdown is continuing. Annual consumer price growth rate declined to 4.3% in August (from 4.6% in July 2019). August results show that annual core inflation also declined to 4.3% vs 4.5% in July. According to the Bank of Russia estimates, most inflation indicators reflecting the most sustainable price movements are close to 4%.

Consumer demand trends constrain inflation. Temporary disinflationary factors also contributed to slowing consumer price growth, including the seasonality shift in fruit and vegetable price dynamics on the back of early new harvest arrival. Annual inflation slowdown is also influenced by the high base effect in respect of the price dynamics of principal types of motor fuel.

In August, households’ inflation expectations somewhat decreased but still remain elevated. Business price expectations showed mixed dynamics amid August ruble depreciation. Annual inflation slowdown paves the way for a future decline in inflation expectations.

Taking actual inflation dynamics into account, the Bank of Russia has lowered its end-of-year annual inflation forecast for 2019 from 4.2-4.7% to 4.0-4.5%. Moving on, according to the Bank of Russia’s forecast and taking into account the monetary policy stance, annual inflation will remain close to 4%.

Monetary conditions. Monetary conditions have continued to ease since the last Board meeting. Among other things, this was driven by the change in expectations of financial market participants with regard to the Bank of Russia’s key rate path and further downward revision of expected interest rate paths in the US and the euro area. OFZ yields and interest rates in most credit and deposit market segments continued to decline. The Bank of Russia’s decisions to cut the key rate and the decline in OFZ yields create conditions for a decrease in deposit and lending rates in the future.

Real sector lending continues to grow on the back of eased monetary conditions. At the same time, annual growth in lending to households has been slowing down since June after noticeable growth in 2018 — early 2019.

Economic activity. The Russian economy’s growth rate is still coming in lower than the Bank of Russia’s expectations. This is driven by weakening external demand for Russian exports on the back of a global economic slowdown as well as by weak investment activity dynamics, including government investment expenditures. July saw continuing annual growth of industrial production; however, leading indicators for July and August point to a potential worsening of economic conditions in industry. Retail trade turnover growth is further declining YoY amid stagnating real disposable household incomes. The labour market creates no additional inflationary pressure. The fact that unemployment remains at historic lows is not driven by expanding labour demand but rather by a simultaneously contracting number of employees and the labour force.

In the first half of the year, fiscal policy had a constraining effect on economic activity. This is in part related to slower than expected implementation of national projects planned by the Government. The expansion of government spending, including investment expenditures, in the second half of 2019 will support economic growth.

Given the weak economic activity observed since the beginning of this year, the Bank of Russia has lowered its GDP growth rate forecast for 2019 from 1.0-1.5% to 0.8-1.3%. Growth rates of the Russian economy in 2020-2021 have also been reviewed downwards considering the expected slowdown in the global economy. Economic growth might accelerate to 2-3% by 2022 should the Government’s measures for overcoming structural constraints, including the implementation of national projects, be realised.

Inflation risks. Disinflationary and pro-inflationary risks are balanced till the end of the year. Disinflationary factors are primarily related to the weak dynamics of domestic and external demand. That said, growth in budget spending in 2019 H2 — early 2020 will potentially be more distributed over time, which lowers pro-inflationary risks posed by this factor. At the same time, should the global economic slowdown be more pronounced, including due to tightening international trade restrictions and on the back of other geopolitical factors, this might lead to strengthened volatility in global commodity and financial markets, affecting exchange rate and inflation expectations.

A number of internal conditions continue to pose pro-inflationary risks over a longer-term horizon. Significant risks are posed by elevated and unanchored inflation expectations. The mid-term inflation dynamics may also be affected by fiscal policy parameters, including decisions on the use of the liquid part of the National Wealth Fund in excess of the threshold level set at 7% of GDP.

The Bank of Russia leaves mostly unchanged its estimates of risks associated with wage movements, prices of individual food products, and possible changes in consumer behaviour. These risks remain moderate.

If the situation develops in line with the baseline forecast, the Bank of Russia will consider the necessity of further key rate reduction at one of the upcoming Board of Directors’ meetings. In its key rate decision-making, the Bank of Russia will take into account actual and expected inflation dynamics relative to the target and economic developments over the forecast horizon, as well as risks posed by domestic and external conditions and the reaction of financial markets.

The Bank of Russia Board of Directors will hold its next rate review meeting on 25 October 2019. The press release on the Bank of Russia Board decision is to be published at 13:30 Moscow time.

In the follow-up to the Board of Directors meeting of 6 September 2019 the Bank of Russia released its medium-term forecast.

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