Friday, October 22, 2021

Russia raises rate 6th time and still sees further hikes

     Russia's central bank raised its main interest rate for the 6th time in response to curb rising inflation and inflation expectations and reiterated that it "holds open the prospect of further key rate rises at its upcoming meetings" if the economy develops according to its expectation.
     The Bank of Russia raised its key rate by a further 75 basis points to 7.50 percent and has now raised it 3.25 percentage points following hikes in March, April, June, July and September.
     The rate is now back to a level last seen in June 2019 before the bank embarked on a monetary easing cycle that culminated with last year's four rate cuts in response to the COVID-19 pandemic.
     "Inflation is developing substantially above the Bank of Russia's July forecast," the bank said, adding inflation expectations are up again and the balance of risks of inflation are tilted to the upside, which may lead to a more sustained deviation of inflation from the bank's 4.0 percent target.
     Russia's inflation rate jumped to 7.4 percent in September from 6.7 percent for the highest rate since June 2016, pushed up by higher prices for food and other products.
     Inflation is estimated to have risen further to 7.8 percent as of Oct. 18 and inflation expectations among households is at new 5-year highs, the bank said.
     The bank raised its forecast for inflation sharply and now expects inflation by the end of this year of 7.4-7.9 percent compared with July's forecast of 5.7-6.2. 
     For 2021 inflation is seen averaging 6.5-6.6 percent, up from 6.0-6.2 percent and 2020's 3.4 percent.
     Inflation next year is expected to decelerate but still remain higher than previously expected. The bank forecast 2022 inflation to average of 5.2-6.0 percent, up from July's forecast of 4.1-4.9.
     By 2023 it expects inflation to return to its 4.0 percent target.
     The bank also raised its forecast for the key interest rate to average 5.7-5.8 percent this year, up from 5.5-5.8 percent, and to rise even further next year to 7.3-8.3 percent from July's forecast of 6.0-7.0 percent.
     Russia's economy recovered sharply in the second quarter, growing 10.5 percent year-on-year, and the bank said it continued to expand in the third quarter, albeit at a slower pace due to supply-side constraints and tightened anti-pandemic measures.
     The bank maintained its forecast for gross domestic product growth to average 4.0-4.5 percent this year, up from last year's 3.0 percent contraction, and growth of 2.0-3.0 percent in 2022.
       The Bank of Russia issued the following statement by its board of directors, followed by a statement by the bank's governor, Elvira Nabiullina:

"On 22 October 2021, the Bank of Russia Board of Directors decided to increase the key rateby 75 b.p. to 7.50% per annum. Inflation is developing substantially above the Bank of Russia’s forecast and is expected to be within the range of 7.4–7.9% at the end of 2021. The contribution of persistent factors to inflation remains considerable on the back of faster growth in demand relative to output expansion capacity. In this environment, given that inflation expectations are up again, the balance of risks for inflation is markedly tilted to the upside. This may bring about a more sustained deviation of inflation from the target. The Bank of Russia’s monetary policy stance is aimed to limit this risk and return inflation to 4%.

If the situation develops in line with the baseline forecast, the Bank of Russia holds open the prospect of further key rate rises at its upcoming meetings. Key rate decisions will take into account actual and expected inflation movements 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. Based on the Bank of Russia’s forecast, given the monetary policy stance, annual inflation will edge down to 4.0–4.5% in 2022 and will remain close to 4% further on.

Inflation movements. Inflation is developing above the Bank of Russia’s July forecast. In September, the paces of monthly seasonally adjusted growth in consumer prices were up markedly. Annual inflation rose to 7.4% (from 6.7% in August). According to an estimate as of 18 October, it went up to 7.8%. Inflation is expected to be within the range of 7.4–7.9% as of the end of 2021.

The acceleration in annual inflation since the second half of August comes in many ways as a result of rising fruit and vegetable prices. However, indicators reflecting the most sustainable price movements appreciably exceed 4% (annualised), Bank of Russia estimates show. This largely reflects the fact that steady growth in domestic demand exceeds production expansion capacity in a wide range of sectors. In this context, businesses find it easier to pass higher costs, including on the back of rising global prices, on to consumers.

At the same time, the impact of one-off supply-side drivers of inflation translates into growing prices for a wider range of goods and services as inflation expectations of households and businesses remain high and unanchored. In October, households’ inflation expectations were up again to a fresh five-year high. Recent data suggest a rise in price expectations of businesses, which are invariably close to multiyear highs. Analysts’ medium-term expectations are anchored close to 4%.

The dominating influence of inflationary factors could lead to a more substantial and prolonged upward deviation of inflation from the target. The Bank of Russia’s monetary policy stance is aimed to limit this risk and return annual inflation to 4%. Under the baseline scenario, annual inflation will edge down to 4.0–4.5% in 2022 and will remain close to 4% further on.

Monetary conditions have not seen any significant changes since the previous meeting of the Bank of Russia Board of Directors. Rising market rates following the increase in the key rate have so far had a limited effect on lending in the context of high inflation expectations.

Yields of short-term OFZs have risen, reflecting expectations for the Bank of Russia to raise the key rate. Yields of medium- and long term OFZs are also up somewhat under the influence of trends in global financial markets. Lending and deposit rates sustain their growth driven by the key rate rises between March and September. Signs have emerged of small inflows of funds into fixed-term ruble deposits. Corporate lending is continuing to grow at rates close to recent years’ highs. Disbursements of mortgage and unsecured consumer loans are still high.  The Bank of Russia’s monetary policy stance will help solidify a trend towards growing appeal of household deposits, protect the purchasing power of savings and ensure balanced expansion in lending.

Economic activity. High-frequency indicators suggest that the economy continued to grow in Q3 albeit at a somewhat slower pace. Based on Bank of Russia estimates, this is largely associated with the return of the Russian economy to a balanced growth path. At the same time, a number of sectors are under increased pressure from supply-side constraints. Their restraining effect on business activity may strengthen against the background of tightened anti-pandemic measures.

Rapid growth in lending, one-off budget payments, rising real wages and households’ low propensity to save, driven by high inflation expectations, support expansion in consumer activity, especially in non-food markets. Growing domestic and external demand and high corporate profits shore up investment activity. A recovery in the services sector is held back by the challenging epidemic situation.

 Moderate inflationary pressure from the labour market persists. Demand for the labour force is growing in many industries. At the same time, many sectors show labour shortages, including due to remaining restrictions on the inflow of foreign labour. The unemployment rate is close to its record lows, with the number of vacancies at its record highs. The state of the labour market suggests that a further increase in steady growth rates of the Russian economy will primarily be conditional on the growth paces of labour productivity.

Taking into account domestic and global economic developments as well as the nature of supply-side constraints, the Bank of Russia expects GDP to grow 4.0–4.5% in 2021. According to the Bank of Russia’s forecast, in 2022–2024, the Russian economy will grow 2.0–3.0% per annum.

Inflation risks. The balance of risks is markedly tilted to the upside. The effect of inflationary factors may be intensified by elevated inflation expectations and accompanying secondary effects.

Further inflationary pressure may come from remaining disruptions in production and logistics chains, staff shortages, as well as structural changes in the labour market as a result of the pandemic. An increase in structural staff shortages may cause labour productivity growth to considerably lag behind wage growth.

Inflationary risks remain to be generated by price movements in global markets. Further changes in food prices will largely depend on the volume and quality of this year’s crops and post-harvest quality preservation both in Russia and abroad.

Short-term inflationary risks are also associated with intensified volatility in global markets caused by, among other factors, a range of geopolitical events, which may affect exchange rate and inflation expectations. Should inflation pressures in the global economy strengthen further, central banks in advanced economies may attempt an earlier normalisation of their monetary policies. This may become an additional source of higher volatility in global financial markets.

Disinflationary risks for the baseline scenario remain moderate. Opening up the borders concurrently with a gradual lifting of restrictions may lead to a recovery in the consumption of foreign services and weaken supply-side constraints, including in the labour market owing to an inflow of foreign labour force.

Medium-term inflation is largely influenced by fiscal policy. In its baseline scenario, the Bank of Russia proceeds from the fiscal policy normalisation path stipulated by the Guidelines for Fiscal, Tax and Customs and Tariff Policy, which assumes a return to fiscal rule parameters in 2022. The Bank of Russia’s forecast also takes into account decisions made by the Russian Federation Government to invest the liquid part of the National Wealth Fund.

If the situation develops in line with the baseline forecast, the Bank of Russia holds open the prospect of further key rate rises at its upcoming meetings. Key rate decisions will take into account actual and expected inflation movements 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.

In the follow-up to the Board of Directors meeting of 22 October 2021 the Bank of Russia released its medium-term forecast.

The Bank of Russia Board of Directors will hold its next rate review meeting on 17 December 2021. The Board decision press release is to be published at 13:30 Moscow time."

Statement by Bank of Russia Governor Elvira Nabiullina in follow-up to Board of Directors meeting on 22 October 2021:

"Good afternoon,

We made a decision to raise the key rate by 75 basis points to 7.50% per annum. This is a significant increase and, obviously, this is not a fine-tuning exercise. This decision is driven not only by the current pace of inflation, but primarily by high inflation expectations and a considerable revision of the forecast compared to July. Inflation will be going down from a higher point than we assumed. This will require a greater tightening of monetary policy than we planned in our July forecast and expected in September.

I will now explain in detail why we have made this decision.

First of all, I would like to talk of inflation.

In August and especially in September, inflation significantly exceeded our forecast. During the first weeks of October, we could see no signs of a weakening of inflationary pressure.

Although the sudden surge in inflation that occurred in September was provoked predominantly by temporary factors, we consider this situation as potentially dangerous as it affects inflation expectations. I would like to remind you that inflation soared in September due to a smaller vegetable harvest and higher costs in livestock production. Meat, milk, and vegetables are all the so-called marker products. When prices for marker products surge, even if their share in the consumer basket is rather small, this might speed up inflation expectations. This is what we observed in sugar and sunflower oil prices last year. Today, inflation expectations are alreadyhigh, and this impact might be even stronger.

Inflationary pressure is still spurred by higher prices in global markets. Recently, prices for food products, coal, non-ferrous metals, and especially natural gas continued to trend upwards. Increased gas prices are pushing up prices for nitrogen fertilisers, which might ultimately become an additional driver of pressure on prices in food markets put by agricultural enterprises’ costs. However, there are also goods demonstrating a stabilisation of prices and even their adjustment downwards. These are steel, iron ore, precious metals, and lumber. Nonetheless, we cannot be confident yet about how steady these trends are. Global markets remain a source of elevated inflation risks.

However, the question is not only and not so much about transitory factors. It is more important that the indicators of steady inflation are above the target. This is about demand-side pressure, or to be more precise, about a considerable gap between the current level of demand and the potential of supply to meet such demand. It is not always possible to build up production capacities quickly. Supply may adjust to demand more slowly due to limited capacities, a shortage of components and raw materials, logistics bottlenecks, and — with regard to the economy in general — due to the lack of a sufficient number of workers.

It may take a long time to overcome these restrictions and ramp up supply. Until these problems are solved, elevated demand will not turn into higher consumption, but will only translate into an increase in prices for those consumers who will be ready — or simply forced — to buy products at higher prices. All other consumers will be unable to purchase more expensive goods. This is exactly what we are observing now. The situation with cars is probably the most telling example.

Excess demand, which cannot be met through an expansion of production, is not a source of additional economic growth. In such an environment, producers have the opportunity to easily pass their extra costs on to consumers. Hence, this discourages companies to enhance production and labour efficiency.

Today, demand is fuelled by high inflation expectations. After the decrease in August and September, households’ and businesses’ inflation expectations are rising anew and have already returned to the peaks recorded in recent years. The longer inflation expectations stay elevated, the more we need to tighten our policy in order to bring inflation back to the target.

We have considerably raised our inflation forecast for this year, as compared to July, namely to 7.4–7.9%. We have also increased the forecast range of the annual average key rate for the next year by 1.3 percentage points, as compared to July. Considering such policy, inflation will decline to 4.0–4.5% next year.

I will now speak of the economic situation. Except oil production subject to the OPEC+ cuts, the economy generally bounced back to its long-term growth trends in the second quarter and even exceeded them in a number of industries. Growth slowed down in the third quarter, which is evidence that the recovery had completed. It should be noted that the third quarter GDP was affected by a decrease in harvest and the worsened epizootic situation. Excluding agriculture, we estimate that GDP growth quarter-on-quarter was positive.

Consumer demand remains the main contributor to the growth. One-time payments to households also supported consumption. The surveyed companies expect a further expansion of demand. According to the data on GDP for the second quarter and recent statistics for the third quarter, gross fixed capital formation also grows fast this year, and even faster than we assumed in our July forecast.

The oil industry is a large sector where there is still a substantial space for the recovery growth. The OPEC+ is gradually easing the oil production cuts. Furthermore, the environment in the global markets of energy commodities has improved considerably. We have raised the forecast oil price for 2021 and 2022, specifically to 70 and 65 US dollars per barrel, respectively.

I will now briefly talk of the situation in the labour market. The unemployment rate has decreased close to its record lows, while the number of vacant jobs has approached its record high. To fill the new jobs, we need either an inflow of labour migrants, or a redistribution of the current labour force among regions, industries, and enterprises. This process is objectively slower than the return of the available labour force to work during the period of the recovery growth. A higher competition for specialists between employers is promoting the conditions for an increase in wages. It is essential that a rise in wages is consistent with the growth of labour productivity in the relevant sectors. Otherwise, it will entail higher costs which enterprises will pass on to consumers, and the rise in nominal wages will be ultimately absorbed by inflation.

We keep our GDP forecast unchanged for the next year and further on. An additional tightening of monetary policy aimed at returning inflation to the target is coherent with the positive contribution of external demand and investments from the National Wealth Fund made to aggregate demand. GDP will increase by 4–4.5% this year and by 2–3% further on, which is in line with the sustainable growth path.

Monetary conditions have changed only slightly after the September meeting. An increase in market rates following the rise in the key rate currently has only a limited effect on them. This is largely associated with the impact of higher inflation expectations. Lending growth rates remained high in all segments, which is the main indicator evidencing that monetary conditions remained accommodative, rather than neutral in the third quarter as well.

Over the period from the September meeting to yesterday, yields on federal government bonds rose by 50–60 basis points. The increase in short-term yields suggests a revision of market expectations regarding the key rate, whereas growth in long-term yields is driven by the trends in global markets.

Deposit rates continued to go up in September—October, although more slowly than in the previous months. Deposit terms are not yet sufficiently attractive to boost households’ demand for this form of savings.

As regards lending, the corporate segment continues to expand steadily. Growth in consumer lending has slowed down somewhat. As regards the mortgage segment, after a slight deceleration in July—August due to the revision of the subsidised mortgage lending programmes, growth sped up again in autumn. In this context, we have revised our forecast range of retail lending growth for this year upwards by 3 percentage points to 21–25%. The forecast for lending in the economy in general remained unchanged. Currently, the actual changes in the credit market are obviously not sufficient to form such monetary conditions that would help bring inflation back to 4% and stabilise it at this level. Our today’s decision will accelerate the adjustment in the credit and deposit market.

As regards risks to the forecast, proinflationary ones currently prevail.

The main risk is that inflation expectations stay elevated for a long time. The longer the price growth rate remains high, even if fuelled by temporary factors, the more considerable this risk is. We could already observe this over the recent three months.

As regards external conditions, proinflationary risks persist as well. In the first place, they are associated with prices for energy commodities and other commodities. The damper mechanisms protect the domestic market against fluctuations of global prices for commodities. However, an increase in foreign producers’ costs might also affect inflation in Russia. For instance, this happens when we import foreign equipment and vehicles made of more expensive metals.

Disinflationary risks are mostly associated with the fact that producer costs might decrease as fast as they have risen. We have recently observed a multifold increase in prices for container shipments. This has pushed up cargo delivery costs worldwide. However, this growth has stopped by the moment. Possibly, even if prices do not decline to pre-pandemic levels, they might adjust downwards considerably closer to their initial level of this year, and later on this will translate into product prices.

Another important disinflationary factor is still recovery prospects in outbound tourism.

I should focus on the anti-pandemic restrictions that are currently introduced. Last spring, we believed that restrictions would cause a slump in demand, that is, provoke disinflationary risks. This is exactly what happened in the second quarter of 2020. However, the experience of the subsequent waves of the pandemic has proven that restrictions are impacting demand increasingly less, whereas supply contracts when enterprises are forced to suspend operations. We consider that restrictions rather have a proinflationary influence now.

The industries that directly depend on restrictions, primarily services, will be affected most considerably. The Government has introduced support measures to aid the most vulnerable industries, first of all small and medium-sized enterprises and their employees. The Bank of Russia, on its part, has allocated a limit of 60 billion rubles within a special 4% refinancing programme for the banks that would issue loans on preferential terms to small and medium-sized enterprises affected by restrictions.

We have also recommended that banks and microfinance organisations should approve restructuring applications for those individuals and entrepreneurs who need this.

I will now speak about our future decisions. It has become more probable that the level of the key rate will be higher, and the period during which the key rate might stay at this elevated level will be longer than we assumed in our previous forecast. According to our baseline forecast, the key rate will average 7.3–8.3% per annum next year, and 5.5–6.5% per annum in 2023. In other words, the key rate will return to its long-term neutral range no earlier than in the middle of 2023.

Thank you for attention."


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