Friday, September 14, 2018

Russia raises rate 25 bps, warns if may tighten again

      Russia's central bank raised its key monetary policy rate by 25 basis points to 7.50 percent, surprising most analysts, and warned it may raise rates further to tackle rising inflation from a weaker ruble that has been hit by capital outflows amid unsettled global financial markets.
      The Bank of Russia underscored its shift to a tightening policy stance by raising its forecast for inflation this year. However, it was still confident that inflation would decline in the first half of 2020 to its 4.0 percent target as the impact of the latest ruble decline and higher taxes peters out.
      The central bank raised its forecast for inflation to finish this year between 3.8 and 4.2 percent, up from July's forecast of 3.5 to 4.0 percent. This forecast reflects the bank's decision to suspend foreign currency purchases.
     Inflation is then expected to peak in the first half of 2019 at 5.0 - 5.5 percent before declining.  
     Russia's inflation rate jumped to 3.1 percent in August from 2.5 percent in July for the highest since August 2017 and faster than forecast by the central bank.
     "Changes in external conditions observed since the previous meeting of the Board of Directors have significantly increased pro inflationary risks," the central bank said, adding inflation was nearing its target faster than expected due to higher food prices and rising prices from the fall in the ruble which raises import prices.
       Inflation expectations by both households and businesses have also risen in light of the lower ruble and some business are already planning to raise their prices this year, ahead of January's increase in Value Added Tax (VAT) to 20 percent from 18 percent.
      The Bank of Russia had been cutting rates steadily from January 2015 until April this year when the ruble tumbled in response to fresh sanctions by the United States, threatening to push up inflation.      
      Between January 2016 and April the central bank cut its rate by 975 basis points.
      But economists were still expecting the central bank to return to its rate-cutting stance as it slowly shifted toward a neutral policy stance with the rate estimated between 6 and 7 percent.
       Between January 2016 and April the central bank cut its rate by 975 basis points, including two cuts this year in February and March.
       In June and July the central bank then left rates steady but its tone turned more hawkish as it began raising its inflation forecast to reflect the decline in the ruble amid higher U.S. interest rates and the government's plan to raise taxes.
      While most economists had expected the central bank to maintain its rate today but prepare markets for a rate hike in October, it is now clear they did not heed last week's warning by the bank's governor, Elvira Nabiullina.
       At a speech in Washington D.C., Nabiullina said she saw no grounds for a rate cut and instead said there were reasons for keeping the rate or even raising it in light of the increased volatility in global and domestic financial markets.
       Underscoring the governor's message, the central bank on Sept. 7 then said in its regular report on market trends that money markets expected a rate hike today as there was risk that inflation could overshoot the 4.0 percent target by the end of this year due to the fall in the ruble from concerns over further U.S. sanctions and along with volatility on financial markets from Argentina and Turkey.
      The ruble has weakened this year although it has risen this week on expectations of higher interest rates and rose further following today's hike. The ruble was trading at 67.7, up almost one percent from yesterday but down almost 15 percent since the start of the year.
     "The ruble's depreciation is related to capital outflow due to changes in external conditions," the Bank of Russia said, adding its current account balance remains stable.
      Despite rising inflation and the falling ruble, the central bank said economic growth remains in line with its forecasts and it retained its forecast for growth this year of 1.5 - 2.0 percent which corresponds to the country's potential growth rate.
      This is in line with the International Monetary Fund's (IMF) forecast for growth this year of 1.7 percent, up from 1.5 percent last year.
      In the second quarter of this year Gross Domestic Product grew by an annual 1.9 percent, up from 1.3 percent in the first quarter.
       For the next three years, the central bank said it had updated its forecast to reflect changes in external conditions and the government's planned measures, including the VAT rise that might have a dampening impact on business activity at the start of next year.
      Growth in 2019 is forecast to range between 1.2 and 1.7 percent and following years might see higher growth as structural reforms take effect.
      The IMF last week forecast 1.5 percent economic growth in 2019.

      The Bank of Russia issued the following press release:

"On 14 September 2018, the Bank of Russia Board of Directors decided to raise the key rate by 0.25 pp to 7.50% per annum. Changes in external conditions observed since the previous meeting of the Board of Directors have significantly increased proinflationary risks. The Bank of Russia forecasts annual inflation to be 5-5.5%in 2019 and return to 4% in 2020. This forecast takes into account the decisions taken with regard to the key rate and to the suspension of foreign currency purchases in the domestic market under the fiscal rule. The Bank of Russia will consider the necessity of further increases in the key rate, taking into account inflation and economic dynamics against the forecast, as well as risks posed by external conditions and the reaction of financial markets.
Inflation dynamics. Annual inflation is returning to 4% faster than expected. Annual consumer price growth increased to 3.1% in August, which is slightly higher than the upper bound of the Bank of Russia forecast. The upward movement of inflation in August is related to the increase in annual food price growth to 1.9%. This was supported by changes in the balance of supply and demand in certain food markets and the past year’s low base effect. Also, prices are adjusting to the ruble exchange rate that has weakened since the beginning of the year. According to Bank of Russia estimates, most annual inflation indicators reflecting the most sustainable price movements are growing. 
Inflation expectations of both households and businesses have slightly increased on the back of the foreign exchange rate volatility. According to the monitoring data of the Bank of Russia, some businesses may adjust their prices in line with the scheduled VAT increase already in late 2018. 
The ruble’s depreciation is related to capital outflow due to changes in external conditions. At the same time, the current account balance remains high thanks to stable prices of Russian export goods and significantly exceeds the amount of external debt repayments scheduled for the coming months. In this context, the Bank of Russia’s decision to suspend foreign currency purchases in the domestic market under the fiscal rule will serve to curtail exchange rate volatility and its influence on inflation over the next few quarters. 
According to the Bank of Russia forecast that takes into account the decisions taken with regard to the key rate and to the suspension of foreign currency purchases in the domestic market under the fiscal rule, by the end of 2018 the consumer price growth rate will be 3.8-4.2%. Annual inflation will peak in the first six months of 2019 reaching 5.0-5.5% by the end of 2019. Quarterly year-on-year consumer price growth rate will draw close to 4% as early as in the second half of 2019. Annual inflation will slow down to 4% in the first half of 2020 when the effects of ruble’s weakening and the VAT rise peter out. 
Monetary conditions. Monetary conditions have slightly tightened under the influence of external factors. OFZ yields have seen a significant increase. Interest rates in the deposit and credit market are gaining momentum. The increase of the key rate will help maintain real interest rates on deposits in the positive territory, which will support the attractiveness of savings and the balanced growth in consumption. 
Economic activity. Updated estimates for 2018 Q2 show that annual GDP growth stood at 1.9%, in line with Bank of Russia expectations. The Bank of Russia keeps unchanged its 2018 annual GDP growth forecast of 1.5-2%, which corresponds to the potential economic growth rate.
The economic growth forecast for 2019-2021, included in the baseline scenario, was updated to take into account changes in external conditions and the estimated influence of the set of fiscal and structural measures to be taken by 2024 on economic performance. In 2019, the forthcoming VAT increase might have a slight constraining effect on business activity, mostly in the beginning of the year. Newly attracted budgetary funds will be used to boost government spending, including spending on investments, as early as 2019. As a result, according to the Bank of Russia forecast, GDP growth in 2019 will range between 1.2% and 1.7%. The following years might see higher growth rates as planned structural measures are implemented.
Inflation risks. The balance of risks has further shifted towards proinflationary risks. Main risks stem from highly uncertain external conditions and their impact on financial markets.
Further yield growth in advanced economies, capital outflow from emerging markets together with geopolitical factors might cause volatility in financial markets to persist, and affect exchange rate and inflation expectations.
The Bank of Russia leaves mostly unchanged its estimates of risks associated with oil price volatility, wage movements and possible changes in consumer behaviour. These risks remain moderate.
The Bank of Russia will consider the necessity of further increases in the key rate, taking into account inflation and economic dynamics against the forecast, as well as risks posed by external conditions and the reaction of financial markets.
The Bank of Russia Board of Directors will hold its next rate review meeting on 26 October 2018. The press release on the Bank of Russia Board decision is to be published at 13:30 Moscow time."


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