On 15 December 2017, the Bank of Russia Board of Directors decided to cut the key rate from 8.25% to 7.75% per annum. Inflation holds at 2.5% and will gradually draw near 4% by late 2018. The extension of the agreement to reduce oil production brings pro-inflationary risks down over a one-year horizon. In recognition of this, the Bank of Russia cut its key rate by 50 basis points. Medium-term pro-inflationary risks still prevail over the risks of inflation’s sustainable deviation downward from the target. The Bank of Russia will continue its gradual transition from moderately tight to neutral monetary policy.
Moving forward, the Bank of Russia’s key rate decisions will be based on its assessment of the balance of risks of inflation’s material and sustainable deviation in either direction from the target, as well as the dynamics of economic activity against the forecast. The Bank of Russia holds open the prospect of some key rate reduction in the first half of 2018.
In making its key rate decision, the Bank of Russia recognised the following factors.
Inflation dynamics. Under the impact of temporary factors annual inflation holds below 3%. It is estimated at 2.5% as of 11 December 2017.
In 2017 Q4, increased supply of farm produce on the back of growing crop productivity and the shortage of long-term storage facilities continued to exert a downward pressure on consumer price growth. As a result, annual food inflation fell to 1.1% in November 2017. The majority of factors associated with the 2017 harvest will cease to have a disinflationary influence in the first half of 2018. The contribution of the exchange rate dynamics to annual inflation slowdown diminishes and will be exhausted in 2018 Q1.
Annual growth in prices of non-food products, which stood at 2.7% in November, is observed to decline, while services prices went up by 4.2% over the year. According to Bank of Russia estimates, the majority of annual inflation indicators reflecting the most sustainable price movements are somewhat below 4%.
The slowdown of inflation was conducive to a decline in inflation expectations, which nevertheless remains unstable and uneven. The anchoring of inflation close to 4% will require both further decrease in inflation expectations and making them less susceptible to price changes.
Annual inflation is expected to be under 3% in late 2017 and come close to 4% by late 2018 as the impact of temporary factors is exhausted.
Monetary conditions. The key rate decision and the potential for its decrease in the future will contribute to further easing of monetary conditions, thus creating prerequisites for inflation to approach 4%. While nominal bank rates keep declining, real bank rates remain in the positive territory. Non-price lending conditions are gradually becoming looser for the most reliable borrowers but are still restrictive.
In the course of the transition to neutral monetary policy, the shape of the yield curve will continue to change from inverted to normal. Given the situation, the potential for lowering the short-term rates is greater than for the long-term ones.
The current conditions continue to encourage savings and ensure that consumption growth is balanced. These trends will persist amid further gradual easing of the monetary policy and low risk appetite of lenders and borrowers.
Economic activity. According to Bank of Russia estimates, at the end of 2017, the economy’s growth rate will be close to the potential at 1.7-2.2%. Therefore, monetary conditions generate low inflationary pressure without restricting economic growth. Although October saw inconsistent trends in the dynamics of economic activity, producer sentiment remains at a relatively high level. It will be further supported by growing domestic demand amid higher real wages as well as by the recovery of the global economy. Unemployment does not generate any excessive inflationary pressure.
In view of the extension of the agreement to reduce oil production, the Bank of Russia has raised its GDP growth forecast for 2018 in comparison to the previous baseline scenario. However, the medium-term prospects of the Russian economy saw no changes. Over the forecast horizon, economic growth will not exceed 1.5-2.0%, which corresponds to the current estimates of its potential level.
Inflation risks. Depending on the situation, a number of factors may cause inflation to deviate from the target both upwards and downwards. They include the dynamics of food and oil prices, which are characterised by high volatility. The fiscal rule will set off the impact of the oil market conditions on inflation and the domestic economic environment as a whole. At the same time, certain factors generate mostly pro-inflationary risks: this includes the situation in the labour market, potential changes in the consumer behaviour, and the nature of inflation expectations.
The extension of the agreement between oil-exporting countries lowers the uncertainty of energy prices’ dynamics and related pro-inflationary risks over a one-year horizon. However, the risks of upward deviation of inflation from the forecast in the medium term still prevail. First, increased structural labour shortage may cause labour productivity growth to considerably lag behind wage growth. Second, inflationary pressure may stem from changes in households’ behaviour as the propensity to save becomes much lower. Third, inflation expectations remain elevated and subject to fluctuations caused by movements in prices of certain goods and services and the exchange rate. Besides, the medium-term balance of risks for inflation dynamics will depend on potential budgetary and tariff decisions in 2019–2020. The Bank of Russia will also monitor risks posed by external factors all over the forecast horizon.
Moving forward, the Bank of Russia’s key rate decisions will be based on its assessment of the balance of risks of inflation’s material and sustainable deviation in either direction from the target, as well as the dynamics of economic activity against the forecast. The Bank of Russia will continue its gradual transition from moderately tight to neutral monetary policy and holds open the prospect of some key rate reduction in the first half of 2018.
The Bank of Russia Board of Directors will hold its next rate review meeting on 9 February 2018. The Board decision press release is to be published at 13:30 Moscow time.