Today's guidance and decision by the Bank of Russia's is in line with its commitment from the previous board meeting in October that it would maintain the rate throughout this year to anchor the downward trend in inflation and then potentially cut the rate in the first half of 2017.
The Bank of Russia cut its key rate by 50 basis points in June, the first cut since July 2015, and since then inflation has decelerated and the exchange rate of the ruble appreciated.
But the central bank said the decline in inflation was partly due to temporary factors, including the higher ruble and higher-than-expected oil prices that have helped keep Russian assets attractive and a good harvest that helped ease food inflation.
"At the same time, a more confident drop in non-food price growth is necessary for sustainable inflation decline," the bank said, adding that "moderately tight monetary conditions need to be maintained in order to encourage households to save and set the trend towards sustainable inflation reduction under the impact of demand-side constraints."
Russia's inflation rate decelerated to 5.8 percent in November from 6.1 percent in October and fell further to 5.6 percent as of Dec. 12, according to the central bank's estimate.
The Bank of Russia confirmed its forecast that inflation will slow to its 4.0 percent target by late 2017, adding the risks that inflation will not reach this target had subsided.
Russia's economy is continuing to recover, with Gross Domestic Product in the fourth quarter expected to grow slightly as activity in the business services sector is rising and high-tech development is advancing along with other non-commodity exports.
Russia's GDP shrank by 0.57 percent in the third quarter for an annual decline of 0.4 percent and the central bank expects growth of less than 1.0 percent next year and then 1.5-2.0 percent in 2018 and 2019 as "positive trends will take time to evolve and take hold."
This growth forecast is based on a "conservative assumptions" about sluggish global growth and average oil prices of $40 per barrel for the entire period, moderate capital outflows and structural constraints in the economy.
In November Russia's industrial output rose by a higher-than-expected annual rate of 2.7 percent after a 0.2 percent drop in October for the strongest growth since December 2014.
Russia's ruble has fallen sharply since mid-2014 from the fall in crude oil prices and the imposition of Western sanctions over the conflict in Ukraine. In 2015 the ruble depreciated by 18 percent against the U.S. dollar but after hitting a low of 82 this January, it has strengthened. Today the ruble was trading at 61.5 to the dollar, up 19.4 percent this year.
The Bank of Russia issued the following statement:
"On 16 December 2016, the Bank of Russia Board of Directors decided to keep the key rate at 10.00% per annum. The Board of Directors notes that the dynamics of inflation and economic activity are overall in line with the forecast and inflation risks have subsided somewhat. Consumer price growth is slowing down in part under the influence of temporary factors, while reduction in inflation expectations remains unstable. Given this decision and considering that the moderately tight monetary policy is maintained, inflation will slow to the 4% target in late 2017. As the trend towards a sustainable decline in consumer price growth takes root, the Bank of Russia will consider an opportunity of cutting the key rate in the first half of 2017. When making its key rate decisions in the months ahead, the Bank of Russia will assess inflation risks alongside with the alignment of inflation dynamics and economic performance with the baseline forecast.
In making its key rate decision, the Bank of Russia Board of Directors proceeded from the following:
Inflation dynamics. Annual inflation continues to decline in line with the Bank of Russia’s baseline forecast. However, this is partly due to temporary factors. According to estimates, as of 12 December 2016 annual price growth fell to 5.6% from 6.1% in October. Price growth has slowed down noticeably in all key groups of goods and services and monthly seasonally adjusted inflation indicators have declined as well. The ruble exchange rate dynamics continues to be conducive to inflation deceleration as oil prices have been higher than expected and Russian financial assets remain attractive to external investors. A good harvest still facilitates a reduction in food inflation. At the same time, a more confident drop in non-food price growth is necessary for sustainable inflation decline.
Households prefer to stick to a savings behaviour model, however, the disinflationary impact of domestic demand is subsiding gradually. Annual growth in real wages may facilitate a gradual recovery of demand for goods and services. Consumer lending dynamics do not entail material inflation risks so far. Moderately tight monetary conditions need to be maintained in order to encourage households to save and set the trend towards sustainable inflation reduction under the impact of the demand-side constraints. This will enable a further decline in inflation expectations of both households and businesses. According to the Bank of Russia forecast, given the decision made annual inflation will slow to the 4% target in late 2017.
Monetary conditions. Moderately tight monetary conditions are still conducive to inflation reduction. Positive real interest rates will be kept at the level which will ensure demand for loans without an intensification of inflationary pressure and will also preserve incentives for savings. The potential of interest rate reduction is limited in the near future.
Economic activity. The economy is progressing towards recovery in line with the Bank of Russia’s baseline forecast. The estimates show that quarter-on-quarter GDP was no longer in decline in Q3 and industrial production expanded in October—November. However, the rebound in economic activity is still heterogeneous among industries and regions. Import substitution is advancing together with certain non-commodity exports and new lines of industrial growth, including the high-tech development. Business activity in services is also on the rise. Positive trends will take time to evolve and take hold.
By the end of 2016, the output of goods and services will decrease by 0.5-0.7% with a slight growth in quarterly GDP to be seen in Q4. We expect moderate economic growth of less than 1% in 2017 and an increase to 1.5-2% in 2018-2019. The labour market is adapting to the new economic conditions and unemployment remains persistently low. The forecast is based on conservative assumptions about sluggish global growth, year-average oil prices of $40 per barrel for the entire forecast horizon, moderate capital outflow and structural constraints in the Russian economy.
Inflation risks. Risks that inflation fails to achieve the 4% target in 2017 have subsided somewhat. These risks stem largely from the inertia of inflation expectations and a decrease in household propensity to save. Price volatility in global commodity and financial markets may also have an adverse impact on exchange rate and inflation expectations. Approving of conservative budget consolidation strategy, including moderate indexation of wages and pensions in the medium-term horizon, makes an uncertainty and inflation risks from fiscal policy subside. At the same time, these risks might increase if government spending rise in higher oil price scenario.
As the trend towards a sustainable decline in consumer price growth takes root, the Bank of Russia will consider an opportunity of cutting the key rate in the first half of 2017. When making its key rate decisions in the months ahead, the Bank of Russia will assess inflation risks alongside with the alignment of inflation dynamics and economic performance with the baseline forecast.
The Bank of Russia Board of Directors will hold its next rate review meeting on 3 February 2017. The press release on the Bank of Russia Board’s decision is to be published at 13.30 Moscow time."
Bank of Russia Governor Elvira Nabiullina added the following statement as a follow-up to the board of directors meeting:
"Today, the Bank of Russia Board of Directors has decided to keep the key rate at 10.00% p.a.
Overall, the economic performance meets our expectations. Inflation is slowing down in line with the forecast and the economy is taking up a recovery path. Fiscal policy-related inflation risks have abated. Inflation expectations are easing up, though remaining above the levels compatible with the inflation target. The global economic and political developments of recent months have shaken global markets. Nevertheless, our medium-term outlook has mainly remained unchanged.
The expected inflation slowdown will allow us to consider a key rate cut in the first half of 2017. The pace of the key rate reduction will meanwhile sustain moderately tight monetary conditions. It is still essential for inflation and inflation expectations to abate steadily.
Let me dwell on the factors we considered in our decision-making on the key rate and its further path.
First. Inflation is slowing down in line with our baseline scenario driven by demand-side restraint, slower cost increase and ruble appreciation.
Our estimates as of 12 December suggest that the annualised growth of consumer prices fell to 5.6%. Accumulated year-to-date inflation stood at 5%, a historic low, by the end of November. We expect inflation to range between 5.4% and 5.8% by the year-end. Inflation is performing even better than we expected a year ago, when we forecast it to be about 6% by the end of 2016.
Prices for all key groups of goods and services have been growing slower in the recent months. Inflation deceleration has become more uniform across regions. We used to be concerned about seasonally adjusted monthly price growth, but in October and November it showed a decline, too.
Food inflation slowed down considerably on the back of heavy crop. Growth rate of service prices is contracting in both administered tariffs and privately provided services. Non-food inflation is in decline, but it is still insufficient to signal sustainable disinflationary processes. Its persistence at an elevated level may point to a weakening in demand-side restraint. Also, it may partially result from a longer response of non-food prices to external shocks and ruble depreciation, as compared with food prices. Such effect manifested itself in the aftermath of the 2008 crisis, and we cannot rule it out now.
We take account of a number of factors which inflation slowdown is driven by. Some of them are temporary in nature. These are ruble appreciation seen in the recent months amid talks on oil production cut, and the above-mentioned crop. These factors will continue to exert their influence in the months to come, but will eventually abate.
Let me emphasise that when we say that some factors are temporary, we do not mean that their impact will necessarily reverse. These are factors with short-lasting effect of about several months. Their scale and focus largely depend on the market and natural phenomena, e.g. shifts in expectations and sentiment in foreign markets. We cannot expect these factors to be everlasting and always favour inflation reduction.
Therefore, we focus on sustainable factors of fundamental, i.e. less changeable, nature. These factors depend on preferences and the specific conduct of economic agents, households and businesses. Generally they are not subject to fast and abrupt changes. It is crucial that we can influence these factors through our monetary policy. They include demand, inflation expectations and costs.
Consumer demand remains sluggish and continues to contribute in inflation slowdown, though to a lesser degree. Real wages have been rising against the past year figures. However, conditions for sustainable growth of real income are yet to be built up. Households are retaining the propensity to save, underpinned, among other things, by positive real deposits rates. The modest increase in sales of some durable goods results from consumers’ willingness to make major purchases they have previously postponed.
Inflation expectations of households are ebbing; however the pace of this decline is insignificant and unaligned with inflation slowdown. Inflation expectations are yet to take a sustainable downward path. Nevertheless, I should say that inflation expectations of the business community have dropped considerably. Market participants and businesses are more responsive to changes in the Central Bank’s policy and the ongoing contraction in the price growth.
Another inflation reducer is a slowdown in producer price growth, which partially resulted from a moderate cost increase. Inflation and inflationary expectations reduction restricts companies’ capability to pass through their costs to prices. The outlook for lower price growth under monetary policy measures boosts further cost cuts and production efficiency.
Prices for raw materials, which have been sustainably low for quite a while, and low rate of tariff indexation by infrastructure companies also contribute to producer price decrease.
Second. Monetary conditions remain moderately tight, favouring ruble deposits and constraining demand for loans.
Nominal rates are gradually easing, driven by the key rate cuts in June and September. Real rates however remain high which means that nominal rates are considerably higher than inflation expectations.
As we conveyed our intention to maintain the key rate through the end of 2016, market participants revised their expectations of the key rate cut. As a result, yield curves in the financial sector shifted upwards. That helped maintain tight monetary conditions necessary to deliver on the 4% inflation target by late 2017 and stabilise inflation at about this rate, as well as drag down inflation expectations.
Overall lending activity remains weak as the annual growth in lending to the real sector has slowed down to levels close to zero. Banks take a cautious approach when selecting borrowers and adhere to overly rigid requirements for new loans. Borrowers themselves remain conservative. This is related to the persistence of demand limitations and a heightened debt load in individual sectors. The bad debt situation is meanwhile gradually stabilising.
As for retail lending, it has seen a marked decline over the past two years. Now this segment is beginning to recover at a pace more rapid than corporate lending. The scale of this process does not impede the decline in inflation. At the same time, growing retail credit, should it be markedly ahead of economic recovery, may bring risks to price stability. If it persistently outruns rising household incomes, it will also bring risks to financial stability. We will continue to watch closely the developments in this segment.
The forthcoming transition of the banking sector to a structural liquidity surplus will not make any meaningful impact on monetary conditions. In order to absorb surplus liquidity, we regularly hold deposit auctions, maintaining money market rates close to the key rate. Doing so, we retain the entire capability to influence interest rates in the economy through our monetary policy toolkit.
Third. The economy is gradually moving towards a recovery phase, which is consistent with the Bank of Russia’s baseline scenario. The recovery in business activity is however slow and varies across sectors.
The paces of annualised GDP decline slowed down in the third quarter to 0.4%. This was a match to our expectations. Annual GDP is set to decline 0.5-0.7%. GDP decline on a quarterly basis stopped in the third quarter as industrial output posted solid growth in October-November on the previous month, so we can expect slightly positive quarterly GDP growth rates in the current quarter.
Even so, the upturn in production and investment activity has yet to become across-the-board. We note the positive impact from import substitution and the advancement of non-oil and gas exports; yet, these developments are still fragmented in nature. In this way, as regards the manufacturing sector, the rebound is ongoing in the production of individual investment and consumer products, in particular, household appliances, footwear, pharmaceuticals, furniture and office equipment. However, the overall positive contribution of such products to industrial production is still small.
In the labour market, the situation is unchanged. The rate of unemployment is sustainably low.
The fourth consideration for us was changing inflation risks. The dynamics of inflation expectations remain a concern to us. At the same time, we note that the uncertainty as regards budget strategy has declined.
As we noted, households’ inflation expectations are trending lower, yet not as quickly as we want them to. More so, inflation risks are connected with the potential decline in households’ propensity to save, as well as with the impact from the ever-changing external environment that affects prices and expectations through currency exchange movements.
In the meantime, clarity has emerged as regards the specific dimensions of fiscal policy, so these risks have receded. The planned indexation of salaries, in accordance to the President’ May decree, and the one-off payment to pensioners will make no substantial impact on inflation. We expect the approved fiscal consolidation and the moderate indexation of tariffs and payments to be implemented, which will help slow down inflation. Adherence to the formulated budget strategy is crucial in case of oil price increase as well. More substantial than planned government spending growth may lead to inflation risks build-up.
Fifth. The recent development in external markets significantly boosts the odds for the higher oil price scenario, especially short term. Having said that, our mid-term forecast in its key points is unchanged.
The two key events in the world which recently weighed in on global markets include the US presidential election results, and the OPEC and other exporters deal to reduce oil production.
Once the joint impact from these events is assessed, it seems more probable that the higher oil price scenario may materialise. Yet, we remain conservative as we formulate our forecast, assuming that annualised price of Urals crude will average $40 a barrel over the whole forecast horizon. We need time to estimate the impact of various factors on oil market developments. This includes the extent to which the production cut deal will be observed; what will be the conduct of non-OPEC suppliers and that of shale oil producers; what will be the dynamics of global demand and the US Fed policy. We should not jump at conclusions.
We admit that oil prices may climb somewhat above the $40 mark a barrel in 2017. However, our vision of the situation and our monetary policy stance will mainly remain unchanged considering that the Russian economy’s reaction to external fluctuations is now weaker. This is confirmed by the results of 2016. Although the external conditions were notably worse than those in the baseline scenario we released a year ago, both GDP and inflation came in close to the readings we predicted in this scenario.
GDP growth rates in 2017 are set to enter positive territory provided that the baseline scenario materialises. In the next two years, economic growth will accelerate to 1.5-2%. The economy may well post higher growth rates in the event structural reforms are implemented.
Over the forecast horizon, our current account balance is set to decline gradually, albeit remaining positive. Net private capital outflow is expected to be low in 2016 at less than $20 billion. Moving forward, they are set to become small by historical standards, standing at $25 billion at most.
The economic recovery will not come with a rise in inflationary pressures from the demand side, even though consumer spending as such will grow. Maintaining a moderately tight monetary policy stance is to help in sustaining a saving behaviour model.
I will emphasise that our objective goes far beyond the simple task to deliver on the 4% inflation target in December 2017. We seek to ensure that inflation is subsequently maintained at this level; to enable this, it is critical that inflation expectations are on a sustainable downward path. We will take this into account in our monetary policy decision making in 2017. We cannot stifle minor inflation fluctuations altogether, and it makes no sense to do that (it even could do harm). It is critical that average price growth rates are low and never substantially deviate from 4%.
Consistently low inflation is set to be among factors enabling extended planning horizon of economic players. This will help implement projects with long payoff periods and favour the buildup of long-term money, a prerequisite for economic success."
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