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.