Reasons for holding rates steady
The December 2016 Monetary Policy Meeting of the Bank of Russia was followed up by a press conference led by central bank chief Elvira Nabiullina. She expressed that the economy was shaping up in a way they had expected and a slowdown in inflation may make the Bank consider a rate cut in H1 2017. However, the rate cut would still result in “moderately tight monetary conditions” which are necessary for inflation to go down to its target level. She outlined five factors which influenced the Bank’s decision:
- Inflation is slowing down in line with our baseline scenario
- Monetary conditions remain moderately tight
- The economy is gradually moving towards a recovery phase
- Changing inflation risks
- The recent development in external markets significantly boosts the odds for the higher oil price scenario
‘Inflation is slowing down in line with our baseline scenario’
Nabiullina informed that according to estimates of Bank of Russia as of December 12, the annualized growth of consumer prices fell to 5.6% while accumulated YTD (year to date) inflation until November was 5% – a historic low. Consumer inflation has stood lower than expected by the Bank’s Board who had expected it to end 2016 at around 6% levels.
Good agricultural produce has resulted into a substantial drop in food inflation. Though non-food inflation has also fallen, its decline is not sustainable yet. The upcoming oil production cut has led the ruble to appreciate, and combined with a bumper crop, has resulted into curbing inflation. However, these are transitory factors whose influence will not continue beyond a few months.
More permanent factors which influence inflation are demand, inflation expectations, and costs. The Bank of Russia intends to influence these factors in order to maintain a more long-term control over inflation.
Demand remains sluggish and continues to hold back inflation, albeit to a lesser degree. Inflation expectations are yet to decline in a sustainable manner, specifically on the household front, with market participants and businesses responding better in this regard. Meanwhile, producer prices continue to put downward pressure on overall inflation.
‘Monetary conditions remain moderately tight’
Due to the rate cuts in June and September, nominal rates are easing gradually. However, real rates remain high, thus indicating that nominal rates are significantly higher than inflation expectations. Due to the central bank’s communicated intention of keeping rates unchanged until the end of 2016 after the last rate cut in September, bond yields rose. This led to maintaining tight monetary conditions.
If yields rise in a financial system, they lead to higher interest rates on loans, thus curbing lending activity and leading to tighter monetary conditions.
Let’s look at the other three factors that the Bank of Russia considered in its December meeting in the next article.