Friday, February 3, 2017

Russia holds rate, chance of first half rate cut diminished

    Russia's central bank left its key policy rate at 10.0 percent, as expected, but dampened hopes that it may lower its rate soon in light of falling inflation by saying its "capability to cut its key rate in the first half of 2017 has diminished" in light of "internal and external developments."
    The Bank of Russia, which last month said it would consider cutting its rate in the first six months of this year as the trend toward a sustainable fall in inflation takes root, said the expected decline in inflation was helping lower inflation expectations but this was partly due to temporary factors, such as the rise in the ruble's exchange rate and a good harvest.
   "Maintenance of moderately tight monetary conditions will constrain inflation risks, including the short-term ones, coming from the launch of the Finance Ministry-conducted purchase of foreign currency in the FX market," the bank said.
    Last week the central bank said it and the finance ministry would buy U.S. dollars when oil trades above $40 a barrel and sell dollars when it is below that level to reduce the impact of volatile oil prices on the economy and public finances. The volume of monthly purchases was seen at $1-$2 billion, an amount it didn't expect to alter the trend of the ruble or add significantly to its reserves.
    Russia's consumer price inflation rate eased to 5.4 percent in December, the lowest since June 2012, from 9.8 percent in January 2016 and as of Jan. 30 if fell further to 5.1 percent.
    The central bank said it would continue with a "moderately tight monetary policy" in order to reach its inflation target of 4.0 percent by the end of this year by continuing to encourage households to save and further reducing inflation expectations of both households and businesses.
    There are no inflation risks from domestic demand and consumer lending although there has been an improvement in sentiment, the bank said.
    Nevertheless, the central bank said there are still risks that it will not meet its 4.0 percent inflation target by the end of this year due to "inertia" of inflation expectations and households' "shrinking propensity to save."
    This may prevent inflation from a sustainable decline as the temporary factors that have pushed down inflation end amid continued external and political uncertainties, which may have a negative impact on the exchange rate and thus inflation.
    After tumbling from lower oil prices in 2015 and conflict in the Ukraine in 2015, the ruble has been on a firming trend since January last year, underpinned by the central bank's tight policy and rising oil prices.
    The ruble was trading around 59.3 to the U.S. dollar today, up 3.4 percent this year.
    Russia's economy shrank by 0.2 percent in 2015, slightly better than the central bank's expectations and lower than the 2.8 percent contraction in 2015.
    Higher wages is expected to support a rise in consumer activity and the central bank expects positive economic growth this year even if growth rates will be low.
   "It takes structural improvements and time for the positive trends to advance and become sustainable," the central bank said.

    The Bank of Russia issued the following statement:

"On 3 February 2017, the Bank of Russia Board of Directors decided to keep the key rate at 10.00% p.a. The Board of Directors points out that inflation performance has been in line with the forecast, inflation expectations are going down gradually, and the economy is recovering faster than previously expected. However, the slower growth of consumer prices is partially attributed to temporary factors. The purchases/sales of foreign currency in the FX market, which Russia’s Finance Ministry intends to carry out under a transitional budget rule, will not bring considerable inflation risks given the Bank of Russia sticks to its moderately tight monetary policy. Inflation is to slow down to the 4% target by late 2017 and hold close to this level in the sequel. Given the internal and external developments, the Bank of Russia’s capability to cut its key rate in the first half of 2017 has diminished. 
In its key rate decision-making the Bank of Russia was guided by the following assumptions.
Inflation. Annual inflation continues to decline in line with the Bank of Russia’s forecast. This is partially attributed to temporary factors — the ruble exchange rate and last year’s heavy crop. December saw a further slowdown in growth of prices for staple goods and services, as well as lower monthly inflation (seasonally adjusted). Non-food inflation slowed down considerably. According to the estimates as of 30 January, annual consumer price growth was down from 5.4% in 2016 to 5.1%.
Domestic demand continues to exert a disinflationary effect. Households are retaining their savings behaviour model, although their sentiment improved. Consumer lending bears no inflation risks. The Bank of Russia’s forecast suggests that given today’s decision and extension of moderately tight monetary policy, annual inflation is to slow down to the 4% target by late 2017 and hold close to this level in the sequel.
Monetary conditions. In order to maintain the propensity to save and anchor sustainable inflation slowdown driven by demand-side restrictions, monetary conditions should remain moderately tight. They should also help bring inflation expectations of households and businesses further down. 
Positive real interest rates will be held at the level which will ensure demand for loans without increasing inflationary pressure and uphold incentives for saving. The Bank of Russia will manage banking sector liquidity with due account taken for the Finance Ministry’s purchases/sales of foreign currency in the FX market and their effect on the money market rates will be almost immaterial.
Economic activity. Economic recovery in 2016 was somewhat above the Bank of Russia’s expectations, as the average annual oil price was close to the baseline scenario assumptions. The Bank of Russia estimates that quarterly GDP growth rates entered positive territory in the second half of 2016, with the positive trend set to hold into the first quarter of the current year. Growth in industrial production (partially driven by import substitution) is ongoing, and so is expansion of non-oil and gas exports in several categories; investment activity is gradually perking up. Unemployment remains steadily low. The labour market is adjusting to the new economic environment, with signs beginning to emerge that skilled labour shortages are finding their way in individual segments. At the same time, the current economic recovery processes still lack consistency across sectors and regions. Polling data reflect an improvement in business and consumer sentiment, which is, going forward, expected to shore up the economic revival processes. The Bank of Russia’s estimates signal that the observed annual rise in real wages will foster gradual growth in consumer activity. It will come without additional proinflationary pressure amid a rise in supply of goods and services. Annual GDP is expected to show positive growth in 2017; however, the rates of economic growth will be low. It takes structural improvements and time for the positive trends to advance and become sustainable.
Inflation risks. Risks remain that inflation will be above the target level of 4% in 2017; having said that, inflation risks are abating on a mid-term horizon. The inertia of inflation expectations and households’ shrinking propensity to save may prevent inflation from consolidating on the path towards the target as the effect of temporary factors comes to an end. External political and economic uncertainty remains elevated, which may negatively affect expectations as regards exchange rate and inflation. Maintenance of moderately tight monetary conditions will constrain inflation risks, including the short-term ones, coming from the launch of the Finance Ministry-conducted purchase of foreign currency in the FX market.
Having said that, the application of the transitional budget rule, accompanied with the Finance Ministry-conducted purchases/sales of foreign currency in the FX market will help lower the dependence of the Russian economy, particularly in terms of monetary conditions and inflation dynamics, on fluctuating oil prices. In the medium term, the application of the budget rule will help bring about macroeconomic stability and more predictable and steadier interest rates in the economy.
Considering the change in the external and internal environment, the Bank of Russia’s capability to downgrade its key rate in the course of the first half of 2017 has diminished.
The next meeting of the Board of Directors of the Bank of Russia to review the key rate is scheduled for 24 March 2017. The Board’s decision press release is to be published at 13:30 Moscow time."


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