The Bank of Russia cuts the key rate by 25 bp to 7.25% per annum
On 26 July 2019, the Bank of Russia Board of Directors decided to cut the key rate by 25 bp to 7.25% per annum. Inflation slowdown is continuing. At the same time, inflation expectations remain elevated. Russian economy’s growth rate is coming in lower than the Bank of Russia’s expectations. Weak economic activity, along with temporary factors, limits inflation risks over the short-term horizon. According to the Bank of Russia’s forecast, taking into account the pursued monetary policy, annual inflation will return to 4% in early 2020.
If the situation develops in line with the baseline forecast, the Bank of Russia admits the possibility of further key rate reduction at one of the upcoming Board of Directors’ meetings and a transition to neutral monetary policy in the first half of 2020. 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 4.7% in June (from 5.1% in May 2019) and was close to 4.6% according to the estimates as of 22 July. June results show that annual core inflation declined for the first time since March 2018 and reached 4.6%. Seasonally adjusted monthly consumer price growth rate slowed down to 0.1% in June vs
Consumer demand trends constrain inflation. Temporary disinflationary factors also contributed to slowing consumer price growth, including ruble appreciation since the beginning of the year and the decline in fruit and vegetable prices on the back of early new harvest arrival. Annual inflation dynamics were also influenced by base effects.
In June and July, business price expectations continued to decline. Households’ inflation expectations have not materially changed since April and remain elevated. Inflation slowdown paves the way for a future decline in inflation expectations.
According to the Bank of Russia’s forecast, taking into account the pursued monetary policy, annual inflation will return to 4% in early 2020.
Monetary conditions. Monetary conditions 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 the downward revision of expected interest rate paths in the US and the euro area. OFZ yields and deposit interest rates continued to decline. The Bank of Russia’s decisions to cut the key rate and the decline in OFZ yields observed since the beginning of this year create conditions for the decrease in deposit and lending rates in the future.
In June, real sector lending continued to grow on the back of eased monetary conditions. Annual growth rate of loans to non-financial organisations reached the maximum level since 2015 while the growth rate of household loans stabilised after a tangible increase in the previous months.
Economic activity. Russian economy’s growth rate since the beginning of the year has been lower than the Bank of Russia’s expectations. This was caused by weak investment activity dynamics and a significant drop in annual export growth rates, including on the back of weaker external demand. The second quarter saw an increase in annual industrial production growth, which may not be steady. Retail trade turnover growth continued to decline YoY amid falling real disposable household incomes. Unemployment remains at the historic lows. However, given the contracting number of employees and the labour force, it does not create any additional inflationary pressure.
In the first half of the year, fiscal policy had additional constraining effect on the economic activity, which is in part related to the shift of implementation schedule of a number of national projects planned by the Government. Since the second half of 2019, government spending, including investment expenditures, is expected to rise.
Inflation risks. Disinflationary risks exceed pro-inflationary risks over the short-term horizon. This is primarily related to the weak dynamics of domestic and external demand.
That said, significant risks are posed by elevated and unanchored inflation expectations. The risk of a slowdown in global economic growth still looms caused, among other things, by the further tightening of international trade restrictions. Geopolitical factors might lead to strengthened volatility in global commodity and financial markets, affecting exchange rate and inflation expectations. Supply-side factors in the oil market may amplify volatility of global oil prices. However, the revision of interest rate paths in the US and the euro area in June and July reduces the risks of considerable capital outflows from emerging markets.
Fiscal policy may cause a meaningful impact on inflation dynamics over both the short- and medium-term horizons. The catch-up growth of budget spending in the second half of the current year may have a pro-inflationary effect in late 2019 — early 2020. Moving on, potential decisions on the use of the liquid part of the National Wealth Fund in excess of the threshold level set at 7% of GDP may exert upward pressure on inflation.
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 admits the possibility of further key rate reduction at one of the upcoming Board of Directors’ meetings and a transition to neutral monetary policy in the first half of 2020. 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 6 September 2019. The press release on the Bank of Russia Board decision and the medium-term forecast is to be published at 13:30 Moscow time.
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