A wider step // The Bank of Russia has raised the rate and is even ready for a tough monetary policy

The increase by the Bank of Russia of the key rate by 0.5 percentage points (p.p.), to 5.5% per annum, became quite predictable, but a number of comments from the Central Bank of this decision changes the situation. The Central Bank’s board of directors – at least for now – considers 0.5 pp instead of 0.25 pp as a possible, albeit temporary, standard step in the fight against inflation. The Bank of Russia is also ready for a temporary transition to a tight monetary policy (MCP), although it is not sure if it is necessary. Finally, the Central Bank does not now consider inflation to be fully imported, despite the fact that the surge in price growth and inflationary expectations in April-June was the norm in the world, and sees it as inflation in demand.

On Friday, the Bank of Russia Board of Directors adopted the decision predicted by all analysts to raise the key rate to 5.5% per annum. These are two standard steps. At a press conference on the same day, the Chairman of the Central Bank Elvira Nabiullina made it clear that in the near future the step of 0.5 pp is more of a standard, the issues of “smoothness of the key rate increase” that motivated the regulator’s earlier steps were not mentioned. According to her, the Central Bank discussed an increase in the key rate by both 0.25 p.p. and 0.75 p.p., but still the “main” options for the reaction on June 11 to a surge in consumer inflation above 6% yoy ( partly due to the “base effect”) for the regulator’s board of directors there were either 0.5 pp or 1 pp. Apparently (the head of the Central Bank did not directly state this, minutes and the regulator did not disclose the voting results), they voted for one of two options, won moderate. With a high probability, at the next meetings of the board of directors, while maintaining the same level of inflation and inflationary expectations, the scenario will persist: 0.5 p.p. looks like a temporary standard for the key rate step – perhaps because by a step of 0.25 p.p. the financial sector reacts sluggishly, and the Central Bank sees the situation as risky.

In the rhetoric of the Central Bank, following the meeting, it was not the main theses that changed, but the rigidity of their approval: it is now unambiguous, it is already difficult to strengthen it. So, in the statement of the head of the Bank of Russia, the current surge in inflation is confidently qualified as “demand inflation” and is opposed to “cost inflation”: this idea is supported by information about the growth of both sales volumes and prices, which for “cost inflation” (to non-technical use the term has questions) is uncharacteristic. In addition, the Central Bank for the first time outlined a mechanism that had not been discussed at all for the Russian economy: the growth of inflationary expectations may lead to the postponement of consumption by households to an earlier date, which additionally inflates prices and inflationary expectations. The missing link in this logic is the attraction of credit resources by households and the reorientation of savings to consumption in fear of an increase in loan rates. In this scenario, the Bank of Russia is clearly inspired by the situation in the mortgage and car markets, while the events of the summer of 2021 appear in this light as a kind of “duel” between the Central Bank and consumers: the former must raise the key rate as soon as possible in order to outstrip consumers seeking to buy an apartment or a car on a loan before banks react to the decision of the Central Bank.

And finally, the main thing in Elvira Nabiullina’s commentary is that the Central Bank now admits, among other things, a temporary transition to a tough monetary policy (the current one is considered soft, and a series of key rate increases – moving from it to a neutral monetary policy). However, the Bank of Russia is not sure that such a transition will be needed, and does not plan its timing (2021 or 2022).

So far, what is happening seems to be a rather “short” story, limited in the summer and autumn of 2021 (after, we note, the “base effect” will cease to work and the harvest, which is expected to be good, will begin to put pressure on prices). Banking analysts reacted very calmly to the decision of the Central Bank. Thus, ING now expects a “ceiling” of the key rate of 6.5%, especially noting “surprisingly increased” hawkish “sentiment” in the Central Bank. Raiffeisenbank notes that the rate of 6.75% “fits into the medium-term forecast of the Central Bank of the average key rate for the year (4.8-5.4%).” The market is actively discussing the prospects for carry-trade on the ruble, however, the strengthening of the national currency is still questionable due to geopolitical risks, but it is obvious that any results of the meeting of the US and Russian Presidents Joe Biden and Vladimir Putin on June 15 in Geneva may cause a sharp instability of the ruble, and this applies to both the vaguely positive and negative results of the summit.

The Central Bank’s opinion that the “imported” inflation in the Russian Federation was only in the fourth quarter of 2020, and now this is an internal phenomenon, is not accepted by everyone. Independent economist Alexander Zotin believes that “most of the reasons are exogenous and are practically not” cured “by the monetary actions of the Central Bank,” and the rate hike will “cool the emerging post-pandemic recovery growth.” He draws attention to the global nature of the inflationary surge, including in the United States (and the Fed’s refusal to react sharply to it), and believes that “the current tight fiscal policy” makes the monetary policy measures “counterproductive”: a reasonable alternative would be “to reduce or eliminate the VAT for socially significant goods and / or targeted assistance to vulnerable groups ”.

Note, however, that while the yield of long-term OFZs has not responded to the actions of the Central Bank (which is especially noted by the Bank of Russia) – it remains at the level of the end of March 2021, the market clearly perceives the surge in inflation as limited. In turn, VTB Capital points to the anti-inflationary role of budgetary policy along with the Central Bank’s monetary policy measures, while the bank’s analysts suggest that by the end of 2021, “the federal budget may be executed with a surplus of 0.2–0.7 trillion rubles … (0.2-0.6% of GDP), while the current budget law provides for a deficit of 2.8 trillion rubles. (2.4% of GDP) “.

Dmitry Butrin

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