The Bank of Russia, which cut its rate last month for the first time since July 2015, added that was keeping rates "at a level that encourages savings, brings down inflation expectations and promotes sustainable inflation reduction to the target level."
Russia's headline inflation rate rose slightly to 7.5 percent in June from 7.3 percent in May, but then resumed its easing trend this month as expected, falling to 7.2 percent as of July 25, the central bank said, helped by a steady financial market, weak consumer demand and administered prices.
"At the same time, there has been a stop in the decline of core inflation, seasonally adjusted monthly growth rates of consumer prices and inflation expectations," the central bank said.
Russia's core inflation rate was steady at 7.5 percent in June and May, down only slightly from 7.6 percent in April.
But the central bank expects inflation and inflation expectations to ease further due to low demand and an expected good crop yield.
The central bank confirmed that it still expects inflation to reach its target level of 4 percent by late 2017 as it dips below 5 percent in July 2017.
Russia's economy is continuing to recover, the bank said, with positive growth in the second half of this year "possible" and annual growth rates entering positive territory next year.
However, some industries are still stagnating or contracting while investment continues to decline while non-commodity exports are still expanding and import substitution is rising.
Russia's Gross Domestic Product shrank by an annual rate of 1.2 percent in the first quarter of this year, up from a fall of 3.8 percent in the fourth quarter of last year.
The Bank of Russia issued the following statement:
"On 29 July 2016, the Bank of Russia Board of Directors decided to keep the key rate at 10.50 percent per annum. The Board notes that inflation dynamics and the nascent rebound in economic activity are overall aligned to the Bank of Russia’s baseline forecast. However, the decline in inflation expectations has stalled. This decision, along with the maintenance of moderately tight monetary policy, will help deliver on the inflation target. The Bank of Russia forecasts that the annual growth rate of consumer prices will be less than 5% in July 2017, to reach the target of 4% in late 2017. The Bank of Russia will consider the possibility of a further rate cut based on estimates for inflation risks and the alignment of inflation decline with the forecast trajectory.
In making the key rate decision, the Board of Directors of the Bank of Russia was guided by the following considerations:
First. Inflation is currently slowing down in line with the Bank of Russia’s baseline forecast. This is helped by the economic environment including steady Russian financial market, persistently weak consumer demand and the indexation of administered prices and rates as previously planned. The Bank of Russia estimates the annual growth rate of consumer prices to decline, as of 25 July 2016, to 7.2%. At the same time, there has been a stop in the decline of core inflation, seasonally adjusted monthly growth rates of consumer prices and inflation expectations. The slowdown of inflation is set to continue, primarily triggered by demand-side constraints. The lower — compared to last year’s — indexation of administered prices and rates in July, as well as the expectations for good crops, will contribute to the slowdown of inflation, helping recede inflation expectations. According to the Bank of Russia forecast, as the moderately tight monetary conditions remain in place, annual inflation will dip below 5% in July 2017 to reach the target level of 4% by late 2017.
Second. The tight monetary conditions will be maintained, although somewhat eased following the contraction of the banking sector’s liquidity deficit and the June 2016 reduction in the Bank of Russia key rate. The real interest rates in the economy (adjusted for inflation expectations) will stay at a mark where demand for credit will be met without heightened inflationary pressure, retaining the incentives to save. To enable operating control over the level and structure of market interest rates, in the context of the switchover to a nascent liquidity surplus in the banking sector, the Bank of Russia will use the appropriate toolset to absorb liquidity.
Third. Production recovery fails to cause consumer price growth amid slack demand. Import substitution steps up and non-commodity exports expand. Economic dynamics are patchy across sectors and regions. Industry, including manufacturing, discovers new opportunities for growth. At the same time, certain industries stagnate or show lower output growth, while investment continues to contract. Nevertheless, the trend for economic recovery prevails. Positive quarterly growth of GDP is possible in the second half of the year. Annual GDP growth is predicted to enter positive territory in 2017.
Fourth. The risks of failure to deliver on the 4% inflation target in 2017 persist following primarily, along with the external risks, the inertia of inflation expectations and the uncertainty over specific fiscal consolidation measures, including wage and pension indexation. The emerging trend towards wage increase and deposit rate cut may undermine households’ propensity to save. To alleviate these risks, the Bank of Russia has to keep rates at a level that encourages saving, brings down inflation expectations and promotes sustainable inflation reduction to the target level.
The Bank of Russia will consider the possibility of a further rate cut based on estimates for inflation risks and the alignment of inflation decline with the forecast trajectory.
The Bank of Russia Board of Directors will hold its next rate review meeting on 16 September 2016. The press release on the Bank of Russia Board decision is to be published at 13:30 Moscow time."