Russia’s central bank became the third emerging market central bank to raise its key interest rate this week, saying a faster-than-expected recovery of economic activity and rising inflation called for a return to neutral monetary policy and it was open to further rate hikes.
The Bank of Russia raised its key interest rate by 25 basis points to 4.50 percent, the first rate hike since December 2018 when the bank raised its rate for the second time that year to stamp out the risk of a rise in inflation from a fall in the ruble that had been hit by fresh sanctions by the United States.
But this brief period of tightening gave way to a return to an easing path in June 2019 after which the Russian central bank cut its rate 9 times and by a total of 350 basis points – including four cuts last year in response to the COVID-19 pandemic as inflation steady declined.
Russia has weathered the pandemic better than many economies and today’s rate hike comes after the central bank at its last meeting in February said the room for further monetary easing had been exhausted.
Not only did the central bank raise its forecast for inflation, but also its expectation for how quickly the economy would return to its pre-pandemic level.
”The pace of economic recovery is higher than expected,” the central bank said today, adding inflation in the first quarter of this year was higher than it had expected and the balance of risks had now shifted toward pro-inflationary factors.
Russia’s rate hike follows that of its fellow emerging market economies of Turkey and Brazil, which also raised their rates this week in response to growing inflationary pressures, boosting the number of central banks that have raised key rates this year to 12.
Russia’s inflation rate has accelerated in the last 9 months and hit 5.67 percent in February from 5.18 percent in January, reflecting the recovery of demand and some supply constraints.
But the central bank expects inflation to peak in March and then decline and gradually return to close to its 4.0 percent target in the first half of 2022 and remaining at that level.
”That said, the Bank of Russia holds open the prospect of further increases in the key rate at its upcoming meetings,” the bank said, adding it would continue to determine the timeline and pace of a return to a neutral policy stance by taking into account inflation along with economic and financial market developments.
This year and onwards, the central bank expects Russia’s economy to gain support from an improved outlook for the global economy and further fiscal support measures around the world, which will accelerate demand for Russia’s export of commodities.
But the central bank also cautioned of volatility in financial markets as the faster-than-expected recovery of the global economy, along with continued extremely accommodative policies in advanced economies, may lead to an earlier normalization of monetary policy.
The Bank of Russia issued the following press release followed by a statement by its governor, Elvira Nabiullina
“On 19 March 2021, the Bank of Russia Board of Directors decided to increase the key rateby 25 b.p. to 4.50% per annum. In the first quarter, the rate of consumer price growth has been higher than the Bank of Russia’s forecast. Domestic demand is recovering more steadily and faster than expected, outstripping the pace of output growth in a number of sectors. The expectations with regard to external demand are also improving on the back of additional fiscal support measures in certain countries and accelerating vaccination paces of the population. Inflation expectations of households and businesses remain elevated. The balance of risks has shifted towards proinflationary ones.
The fast recovery of demand and elevated inflationary pressure call for a return to neutral monetary policy. The Bank of Russia will continue to determine the timeline and pace of a return to neutral monetary policy taking into account actual and expected inflation dynamics 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. That said, the Bank of Russia holds open the prospect of further increases in the key rate at its upcoming meetings. Given the current monetary policy stance, annual inflation will return to the Bank of Russia’s target close to 4% in the first half of 2022 and will remain at that level further on.
Inflation dynamics. Inflation is developing above the Bank of Russia’s forecast. In February, the annual consumer price growth rate rose to 5.7% vs 5.2% in January and, according to the 15 March assessments, reached 5.8%. Based on Bank of Russia estimates, indicators reflecting the most sustainable price movements substantially exceed 4% (annualised).
This largely reflects a steady nature of the recovery in domestic demand. Its influence on price growth rates is enhanced by restrictions on foreign travel. The funds that households have been unable to spend for this purpose are partially redistributed in favour of domestic goods and service consumption. Additional pressure on price growth is exerted by supply-side factors that constrain the production of certain goods.
Inflation expectations of households remain elevated compared to the pre-pandemic period. Businesses’ price expectations also remain at an elevated level. Analysts’ medium-term expectations are anchored close to 4%.
The fast recovery of demand and elevated inflationary pressure call for a return to neutral monetary policy. The Bank of Russia forecasts that annual inflation will peak in March and go down further on. Given the current monetary policy stance, annual inflation will return to the Bank of Russia’s target close to 4% in the first half of 2022 and will remain at that level further on.
Monetary conditions remain accommodative and have not seen any significant changes since the previous meeting of the Bank of Russia Board of Directors. Short-term OFZ yields rose reflecting the expectations of a faster return to neutral monetary policy by the Bank of Russia. Growing yields of medium- and long-term OFZs largely reflect the increase of interest rates in global financial markets. Loan and deposit rates mainly remained unchanged. Lending continues to grow at rates close to recent years’ highs. Apart from accommodative monetary conditions, lending dynamics are influenced by the preferential programmes implemented by the Government as well as by regulatory relaxations. When making its key rate decisions, the Bank of Russia will consider the impact of cancelling these anti-crisis measures on monetary conditions.
Economic activity. The pace of economic recovery is higher than expected. According to the Bank of Russia’s monitoring, increasingly more businesses report that their production rate has returned to the pre-pandemic level. The recovery in retail trade and services is supported by a gradual lifting of restrictions. However, in certain sectors, the capacity for output expansion is lagging behind the expanding demand. Consumer sentiment continued to improve in January—February. Market surveys demonstrate that businesses’ expectations remain positive.
In 2021 and onwards, Russian economic growth will gain support from an improved outlook for the global economy as further fiscal support measures are rolled out across a number of countries, which is set to accelerate growth in demand for Russian export commodities. The medium-term economic growth path will be markedly influenced by the paces of vaccination in Russia and globally, the efficacy of vaccines against new virus strains, the nature of recovering private demand, as well as by the path of budget consolidation.
Inflation risks. The balance of risks has shifted towards proinflationary ones. The impact of proinflationary factors may prove more protracted and expressed against the backdrop of outrunning growth in consumer demand relative to the capacity of output expansion. Their impact may be further strengthened by elevated inflation expectations and the associated secondary effects.
Further upward pressure on prices may continue to come from temporary disruptions in production and supply chains. Proinflationary risks are generated by price movements in global commodity markets, including supply-side factors. This could have a bearing on domestic prices of relevant goods.
Short-term proinflationary risks are also connected with stronger volatility in global markets, driven by various geopolitical developments, among other factors, which may have an effect on exchange rate and inflation expectations. Given that the global economic recovery is progressing at faster paces than previously expected and the need is no longer in place for extremely accommodative policies in advanced economies, an earlier monetary policy normalisation by central banks in these countries is possible. This may become a further driver of volatility growth in global financial markets.
Disinflationary risks in the baseline scenario have receded. 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 in the labour market through inflows of foreign labour force. The economic recovery may be held back by a slower rollout of vaccination programmes, the spread of new virus strains, and the entailing toughening of restrictions, among other factors. Persistent changes in consumer preferences and behaviour including a potentially higher propensity to save are poised to exert a constraining influence on inflation.
Medium-term inflation is significantly impacted by fiscal policy. In its baseline scenario, the Bank of Russia proceeds from the parameters of the federal budget and the budgets of constituent territories reflected in the Guidelines for Fiscal, Tax and Customs and Tariff Policy for 2021 and the 2022–2023 Planning Period, as well as from the announced time frames for the completion of anti-crisis measures of the Government and the Bank of Russia. The Bank of Russia will factor in the implications for the forecast of potential investment decisions as regards the liquid part of the National Wealth Fund in excess of the 7% GDP threshold.
The Bank of Russia will continue to determine the timeline and pace of a return to neutral monetary policy taking into account actual and expected inflation dynamics 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. That said, the Bank of Russia holds open the prospect of further increases in the key rate at its upcoming meetings.
The Bank of Russia Board of Directors will hold its next key rate review meeting on 23 April 2021. The press release on the Bank of Russia Board decision and the Bank of Russia’ medium-term forecast are to be published at 13:30 Moscow time.”
Statement by Bank of Russia Governor Elvira Nabiullina in follow-up to Board of Directors meeting 19 March 2021:
“Today, we made a decision to raise the key rate by 25 bp to 4.50% per annum.
The economy is reviving more steadily now, and both domestic and external demand is growing. However, inflationary pressure has intensified, and proinflationary risks have increased. In these conditions, we are beginning to return to neutral monetary policy. As a result, this will bring back annual inflation to our target close to 4% in the first half of 2022.
I would like to dwell on the factors behind the decision we have made today.
First. The steady components of annual inflation and current price growth in annualised terms are considerably above 4%. This is the evidence of elevated inflationary pressure across a wide range of products.
Such acceleration of price growth has been driven by both demand- and supply-side factors.
Last year, consumer demand had a disinflationary impact, while now it is becoming proinflationary as demand is expanding. The epidemic situation in Russia is improving, vaccination is now under way, and authorities are lifting restrictions. People are gradually returning to their normal life, making purchases they postponed before. This is evident from an increase in the sales of household appliances, electronics and home improvement goods and the rise in the demand for leisure and travels. Moreover, the funds that were earlier spent on outbound tourism have been recently used predominantly inside Russia.
Demand is bouncing back steadily, while the recovery of supply will require more time. It is impossible to restore production and supply chains instantly, especially given the restrictions still in place locally. Companies will need time to adjust their business plans to a faster recovery of demand, find additional suppliers, employ staff, and expand output. A very good example is domestic tourism. The shift in the overall tourist flow has happened quite fast and unexpectedly. The tourism segment did not have sufficient infrastructure for that, which has affected pricing.
One-off factors have exacerbated inflation rates and expectations that are elevated even without this influence. Food price growth sped up the most. The measures implemented by the Government have helped smooth out these price rises partially.
The elevated growth rate of prices for basic goods is especially important for consumers and considerably increases inflation expectations. As a result, the steady component of price growth may rise for a prolonged time. We can see that households’ inflation expectations are currently above pre-pandemic levels, although they have lowered as compared to the peak recorded in December. It is necessary to prevent further inflation acceleration. Therefore, inflation expectations need to be reduced as soon as possible.
Overall, the balance of factors has shifted towards proinflationary ones.
Second. Economic growth exceeds expectations and is becoming steadier. This is driven by the rebound of both domestic and external demand. External demand promotes Russian exports, specifically of metals, chemicals, and food. High-frequency indicators suggest that economic activity and employment are growing.
Consumer demand has been recovering steadily since the end of 2020. The demand for durable goods has been rising. As more households are improving housing conditions, this is boosting the demand for accompanying goods, including tools, construction materials, furniture, and household appliances. The demand for cars also remains high. All this supports output in respective industries. Many of them have already restored their output or even increased it above pre-pandemic levels, including in the manufacture of furniture and household appliances, clothing and fabrics, fertilisers, paints and varnishes, agricultural machinery, and electric equipment.
The service sector hardest hit by the pandemic continues to recover, which is evidenced by high-frequency indicators proving that business activity in services has improved considerably.
We expect further economic growth. The upward trend will be supported by vaccination and the extension of a part of preferential government programmes. Fiscal policy will remain expansionary throughout 2021 as compared to the parameters provided for by the fiscal rule.
Third. Monetary conditions remain accommodative. Moreover, yields on federal government bonds have risen since the Board of Directors’ previous meeting on the key rate. The increase in short-term yields was driven by the expectations that the Bank of Russia will shift towards neutral monetary policy earlier and faster. Medium- and long-term yields on federal government bonds were primarily influenced by rising interest rates in global financial markets. Nonetheless, nominal interest rates on loans and deposits have not changed significantly.
Monetary conditions will remain accommodative until the key rate returns into the neutral range (which is still from 5% to 6% according to our estimate). This will continue to support lending, the annual growth rate of which is currently close to its several-year high.
Monetary conditions are considerably impacted by the preferential lending programmes implemented by the Government. They are easing monetary conditions even more, and the extent of this influence depends on the scale of programmes, the amounts of subsidies, and the maturities of credit instruments they cover. When their scale is significant, this implies that the Central Bank has to maintain tighter conditions for everyone. This is needed for average monetary conditions across the economy to ensure the level of aggregate demand corresponding to the goal of achieving the inflation target. This is the reason why we believe it essential to terminate comprehensive anti-crisis programmes supporting lending after the country overcomes the acute phase of the economic crisis. We also insist that any permanent programmes should only be limited and targeted. Otherwise, they will be paid for not only by the budget, but also by the major part of the economy which will face higher interest rates.
I will now speak on the factors that may significantly impact inflation on the longer run. These are predominantly proinflationary ones.
Speaking of external demand factors, accommodative monetary policies and fiscal stimuli in advanced economies may encourage a faster recovery of the global economy than expected today. On the one hand, the demand for Russian exports will expand, which will bring additional revenues to exporters and have an upward impact on domestic demand. On the other hand, the growth of global prices in commodity markets may speed up. Consequently, this may involve the risk that this growth will translate into the trends of respective domestic prices. We are already observing this in the food segment.
As regards domestic demand, consumption may be expanding even faster, including in services, exceeding the recovery pace of output.
We can also identify proinflationary supply-side risks that are primarily caused by increased input costs. Moreover, a range of industries are already experiencing staff shortages, which may hinder the expansion of output.
As before, the further development of the epidemic situation worldwide is highly uncertain. A range of countries are tightening restrictions again and partially suspending economic activity. Geopolitical risks remain elevated as well, and they may affect yield trends and inflation and exchange rate expectations.
The Bank of Russia will also factor in how our medium-term forecast may be influenced by possible government decisions on investing the National Wealth Fund’s resources.
Disinflationary factors have weakened, but still exist. First of all, it is yet unclear how fast countries will be reopening boundaries after the pandemic recedes. In a situation where boundaries are fully reopened, households may be realising the pent-up demand for foreign travels very fast. As a result, demand will be transferred to external markets. This will weaken inflationary pressure. I would like to remind you that before the outbreak of the pandemic expenses for outbound tourism approximated 2 trillion rubles a year. However, if people remain cautious about foreign travels, a substantial portion of households’ funds will remain inside Russia. It is now difficult to say which of the two options will become the reality. Furthermore, the reopening of boundaries will restore labour migrant flows and logistics chains, which will decrease inflationary pressure caused by companies’ input costs.
In conclusion, I would like to comment on the shift towards neutral monetary policy.
We have seen that the money market and the bond market have already included a potential key rate increase into asset prices. Nonetheless, a large number of experts and analysts assumed that the Bank of Russia would begin to raise the key rate slightly later. However, the data available prove that we need to start returning to neutral monetary policy already now. Time really matters: if we delay a key rate increase, inflation may go up and inflation expectations will not lower. Inflation will deviate from the target even more, and consequently, we will need to increase the key rate more significantly in the future.
Rephrasing a popular expression, I would say that we have put the right comma in the phrase ‘to preserve impossible to raise’.
Thank you very much for your attention.”