Moscow September 15 2023: On Friday, the Bank of Russia Board of Directors decided to increase the key rate by 100 basis points to 13.00% per annum as inflationary pressure in the Russian economy remains high.
Significant proinflationary risks have crystallised, namely the domestic demand growth outpacing the output expansion capacity and the depreciation of the ruble in the summer months. Therefore, it is required to additionally tighten monetary conditions to limit the upward deviation of inflation from the target and return it to 4% in 2024. The return of inflation to the target and its further stabilisation close to 4% also implies that tight monetary conditions will be maintained in the economy for a long period.
The Bank of Russia will make its further decisions on the key rate, taking into account actual and expected inflation movements relative to the target and the progress of the structural transformation of the economy, as well as assessing risks from internal and external conditions and financial markets’ response to these risks. The Bank of Russia will consider the necessity of further key rate increase at its upcoming meetings. According to the updated forecast of the Bank of Russia, annual inflation will stay at 6.0–7.0% in 2023. Given the monetary policy pursued, annual inflation will return to 4% in 2024 and stay close to 4% further on.
Inflation movements. As estimated as of 11 September, annual inflation has increased to 5.5% from 4.3% in July and 5.2% in August. Current inflationary pressure has intensified, also because of the pass-through of the ruble weakening to prices. Over the last three months, the current price growth totalled 9.9% on average in annualised terms on a seasonally adjusted basis. The same measure of core inflation rose to 8.4%.
Higher inflationary pressure is seen across an increasingly broader range of goods and services. Growing domestic demand exceeds the output expansion capacity. High domestic demand has been an important factor behind the ruble’s depreciation via elevated demand for imports.
The pass-through of the ruble weakening to prices is speeding up due to high inflation expectations. Price expectations of businesses have increased most significantly in recent months. Households’ inflation expectations have also risen. Analysts’ inflation expectations for 2023 and 2024 have increased as well, but they are anchored close to 4% for the medium term.
According to the updated forecast of the Bank of Russia, annual inflation will range from 6.0% to 7.0% in 2023. The Bank of Russia’s monetary policy will limit the upward deviation of inflation from the target. Given the monetary policy pursued, annual inflation will return to 4% in 2024 and stay close to 4% further on.
Monetary conditions began to tighten following the key rate increases in July—August. Interest rates in the credit and deposit market have risen. Higher nominal interest rates have had a minor effect on lending amounts as yet. This is predominantly due to the fact that monetary policy impacts the economy and inflation with time lags.
Short-term OFZ yields have risen significantly since the Bank of Russia Board of Directors’ unscheduled meeting. The OFZ curve has flattened. This shows that current monetary conditions are moderately tight.
Lending activity remained high in both corporate and retail segments. This is partly associated with new loans issued by banks on previously approved terms. The inflow of household funds into credit institutions remained stable. However, some funds were transferred from current accounts to time deposits.
The large volume of existing government subsidised lending programmes, especially in the mortgage market, slightly reduces the impact of the key rate decisions on the lending dynamics. Taking into account rising inflation expectations and remaining levels of nominal rates, such programmes become more attractive to borrowers. All else being equal, this means that a tighter monetary policy is required to maintain price stability.
The key rate decision made by the Bank of Russia will speed up the formation of monetary conditions needed to ensure balanced growth in lending and sustainable disinflationary trends in the economy.
Economic activity is growing across a wide range of industries. High domestic demand is intensifying the upward deviation of the Russian economy from the balanced growth path. This is also the reason behind a persistently elevated demand for imports. High demand for imports coupled with reduced exports is a key factor of the ruble’s depreciation since early 2023. Demand for imports will be adjusting to the weaker ruble and the adopted key rates decisions in the coming quarters.
The expansion of private demand along with a continuously high level of public demand is facilitating strong growth in domestic demand. Growing consumer activity is supported by the expansion of lending, increased real wages, and the adjustment of households to the new structure of supply in commodity markets.
The Russian economy has completed the recovery phase. That means that its further growth will slow down due to supply-side constraints. First of all, it concerns the labour market which is becoming tighter. Unemployment has dropped to a new historical low. Concurrently, low geographic and cross-sectoral labour force mobility is an additional structural constraint.
The Bank of Russia’s monetary policy pursued will create the conditions for returning the economy to the balanced growth path. In its baseline scenario, the Bank of Russia forecasts that the GDP growth rate will be 1.5–2.5% in 2023, 0.5–1.5% in 2024, 1.0–2.0% in 2025, and 1.5–2.5% in 2026.
Inflation risks. Proinflationary risks remain significant over the medium-term horizon.
Persistently elevated inflation expectations and their further increase pose a significant risk. In this case, lending will continue to expand at an accelerated rate, while household propensity to save will decrease. As a result, the domestic demand growth will outpace the supply expansion capacity, intensifying persistent inflationary pressure in the economy. Due to a lack of available labour force, the labour productivity growth may lag behind the growth in real wages.
Inflation risks are also related to geopolitical tensions affecting foreign trade terms. As a result, expanding foreign trade and financial restrictions can further weaken demand for Russian exports, contributing to inflation through exchange rate movements. Moreover, the increasing complexity of supply chains and payments due to the external restrictions could push up import prices. Major short-term proinflationary effects may also stem from the worsening of future global economic growth.
Disinflationary risks are primarily related to domestic demand slowing down faster than projected in the baseline scenario. In addition, growth in prices for key Russian exports or an increase in their physical volumes may result in a stronger ruble.
The Bank of Russia’s baseline scenario rests on the decisions already made regarding the mid-term expenditure path of the federal budget and the fiscal system as a whole. In case of a further budget deficit expansion, tighter monetary policy may be required to return inflation to target in 2024 and keep it close to 4% further on.
The return of inflation to the target in 2024 and its further stabilisation close to 4% implies that tight monetary conditions will be maintained in the economy for a long period. The Bank of Russia will make its further decisions on the key rate, taking into account actual and expected inflation movements relative to the target and the progress of the structural transformation of the economy, as well as assessing risks from internal and external conditions and financial markets’ response to these risks. The Bank of Russia will consider the necessity of further key rate increase at its upcoming meetings.
