Thursday, December 11, 2014

Russia raises rate 100 bps, will raise if inflation rises

    Russia's central bank raised its key policy rate by 100 basis points to 10.50 percent to curb inflation and warned that "in the case of further aggregation of inflation risks, the Bank of Russia will continue to raise the key rate."
     The Bank of Russia, which has now raised its rate by 500 basis points this year to shore up the falling ruble and halt rising inflation, expects inflation to be around 10 percent by the end of this year and even higher in the first quarter of 2015 before declining toward the bank's target of 4.0 percent in the medium term.
    Last month the central bank forecast 2014 inflation of 8.2-8.4 percent and 6.2-6.4 percent in 2015.
     "Should inflation and inflation expectations show a stable downward trend, the Bank of Russia will be ready to start monetary easing," the central bank said.
    The central bank also lowered its economic forecasts due to the impact of lower oil prices, the inability of Russian borrowers to tap foreign financial markets and tighter lending conditions that are leading to a contraction of fixed capital investment, slowing wage growth and retail lending.
    The central bank said it expects Russia's Gross Domestic Product to grow by 0.6 percent this year, up from its November estimate of 0.3 percent, and forecast 2015-2016 growth of close to zero.
    By 2017 the bank expects economic activity to start recovering as the floating exchange rate helps the economy adjust with import-substituting industries emerging and higher non-commodity exports.

    Russia's consumer price inflation rate rose to 9.4 percent as of Dec. 8 from 9.1 percent in November and 8.3 percent in October, the bank said, with prices boosted by the depreciation of the ruble and external trade restrictions, pushing up inflation expectations.
    But the central bank took comfort in the fact that the growth in annual money supply from tighter conditions had eased to 4.8 percent as of Dec. 1 from 14.6 percent a year earlier while higher interest rates on household deposits should stimulate savings and lending growth should slow, helping offset some of the inflationary forces.
     Russia's ruble has been under pressure this year due to the conflict with Ukraine and last month the central bank floated the ruble but has continued to intervene in foreign exchange markets to defend its value.
     Despite the central banks rate rise today, the ruble continued to depreciate and was trading around 55.18 to the U.S. dollar, down from levels around 54.8 on Tuesday. Since the beginning of the year, the ruble has depreciated by some 40 percent.
    The Bank of Russia issued the following statement:

"On 11 December 2014 the Bank of Russia Board of Directors decided to raise the Bank of Russia key rate to 10.5 percent per annum. In November — early December 2014 the upward movement of consumer prices kept on accelerating. Observed increase in inflation expectations and ruble depreciation expectations pose substantial inflation risks. The decision taken by the Bank of Russia is aimed at slowing consumer prices growth to the target of 4% in the medium run. In case of further aggravation of inflation risks, the Bank of Russia will continue to raise the key rate. 
In November — early December, inflation continued to accelerate. According to the estimates as of the 8 of December, annual consumer prices growth rate was equal to 9.4%. Core inflation rose to 8.9% in November 2014. Accelerated consumer prices growth is driven by ruble depreciation in the second half of 2014. External trade restrictions imposed in August 2014 also affected price dynamics. Meanwhile, price growth rate for certain food items flattened out due to the increase of supply by the Russian companies and new import contracts. Amid accelerated consumer prices growth, households’ and businesses’ inflation expectations continued to surge imposing additional pressure on prices. According to the Bank of Russia estimates, end of the year inflation will be around 10%. At the same time, the cumulative contribution of ruble depreciation, restrictions on imports and other factors specific for the markets of several food products, to year-to-year consumer prices growth will account for 4.9 percentage points by the year-end. 
Tighter monetary conditions have not offset the influence of the pro-inflationary factors. However, current monetary conditions set the ground for inflation decline in the medium run. According to the estimates as of the 1 of December 2014, annual money supply (M2) growth rate decreased to 4.8% from 14.6% a year earlier. Continuing growth of interest rates on household deposits stimulates the propensity to save and increases the attractiveness of deposits. Given lending rates hike and tighter borrower and collateral requirements, lending growth (adjusted for currency revaluation) slows down. Given the decision made today and time lags of the influence of the interest rate decisions made by the Bank of Russia earlier, on the economy, this process will continue. 
According to the Bank of Russia estimates, the annual GDP growth rate will amount to 0.6% in 2014. Economic slack does not have considerable restraining effect on consumer prices growth as it is mostly caused by structural factors. Utilisation of productive factors — labour force and commercially viable productive capacities — is high though labour productivity grows slowly. Due to the long-term demographic trends labour supply shrinks. The remaining external political uncertainty and considerable deterioration of external conditions, resulting from oil price drop and foreign financial markets inaccessibility for the Russian borrowers, also have an adverse impact on economic activity. Amid the increase in prices for the imported investment goods, limited access to long-term financing, and tighter lending conditions, fixed capital investments are contracting. Meanwhile, though the real wage growth and retail lending are slowing, consumer demand remains relatively high due to higher demand for non-food items amid higher inflation expectations. The exchange rate dynamics partially balances the negative impact of deterioration of the external conditions and contributes to higher competitiveness of Russian goods. Besides, restrictions on the import of certain food items support the relevant industries. 
Due to the considerable change in the external conditions, the Bank of Russia revised its medium-term macroeconomic forecast. During the next three-year period, economic growth will be lower than previously projected in the baseline scenario due to persistently lower oil prices. Annual GDP growth is expected to be close to zero in 2015-2016. Amid persistently restricted access to the international capital markets for Russian companies and relatively cheap energy resources, fixed capital investments will continue to edge lower. Consumption will remain weak. At the same time, the new exchange rate mechanism will set grounds for more rapid adjustment of the Russian economy to changing external conditions. Economic activity is expected to start recovering in 2017 due to the development of import substituting industries and increase in non-commodity exports. 
Over the next months, prices for goods and services will continue to be affected by depreciation of the ruble. During the first quarter of 2015 inflation might be higher than 10%. Nevertheless, inflation and inflation expectations are forecasted to decrease as the impact of the exchange rate dynamics on prices exhausts and economy gradually adjusts to changing external trade conditions and imposed restrictions on imports. Slowdown in consumer prices growth will also be facilitated by subdued aggregate demand with total goods and services output remaining below the potential. The current stance of monetary policy will result in inflation decrease to the target level of 4% in the medium term. In case of further aggravation of inflation risks, the Bank of Russia will continue to raise the key rate. Should inflation and inflation expectations show a stable downward trend, the Bank of Russia will be ready to start monetary policy easing. 
The next meeting of the Bank of Russia Board of Directors on the key rate is scheduled for 30 January 2015. The press-release on the Bank of Russia Board of Directors’ decision is to be published at 13:30 Moscow time."


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