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Key rate cuts may not be enough to return to target inflation

The Central Bank may take the next step in December. On October 25, the Board of Directors of the Central Bank lowered its key rate by 50 basis points (bp), it became 6.5%, and at the same time lowered its inflation forecast at the end of the year from 4-4.5% to 3.2-3.7%. The rate cut was the fourth and largest in a year.

According to the Federal State Statistics Service, annual inflation as of October 21 was 3.8%, which is lower than the Central Bank target of 4%. Inflation slows down faster than the Central Bank expected, but economic growth remains restrained, the Central Bank states.

The new inflation forecast looks realistic, says Kirill Tremasov, director of the Loko-Invest analytical department. It reflects the absence of inflationary threats and the persistence of risks for economic growth, agrees RDFII chief economist Dmitry Polevoy. “The situation in the economy has become less predictable, and central banks, including the Bank of Russia, are flexibly adapting to this reality”, summarizes Alfa Bank’s managing director Vladimir Verkhoshinsky.

From the previous meeting of the Central Bank’s board of directors, a 5% drop in oil prices and an increase in the ruble exchange rate by 3% took place, and inflation expectations, according to the Central Bank, fell from 8.9 to 8.6% in October, the last time the rate fell so low in May 2018, Core inflation, although it reached the target of 4% in September 2019, it is after 4.6% in July. And monetary inflation, according to the Ministry of Economic Development, in September became the lowest in the entire history of observations.

By sharply lowering the rate, the Central Bank could also respond to the savings behaviour that the population has returned to in the last month, and to the fear that the government will not fulfill the spending plan, Dmitry Dolgin, chief economist at ING in Russia, believes.

Gazprombank's chief economist Sergei Konygin warns that if weekly inflation stays near zero, then by the end of the year, annual inflation could be below 3%. The risks of accelerating inflation due to domestic demand remain low until the end of the year if we rely on data from retail trade and paid services, he says.

In 2020 the Central Bank predicts 3.5–4% inflation, and then a sharp decrease in the rate does not seem necessary now, the chief economist of Alfa Bank Natalia Orlova was surprised. In her opinion, the decision of the Central Bank contradicts macroeconomic indicators: for example, after the meeting of the Central Bank in September, GDP growth accelerated from 0.7%, what it was in the first half of the year, to 1.9%, what it became in the III quarter (data from Rosstat and the Ministry of Economic Development respectively). But GDP growth in the III quarter is largely ensured by the growth of stocks, experts from the Center for the Development of the Higher School of Economics, including agricultural, after the harvest, say one cannot be too optimistic.

For inflation to begin to return to the target 4%, more than one reduction in the rate may be required, says Oleg Shibanov, director of the Skolkovo-NES financial centre. Experts interviewed by Vedomosti do not rule out a decline as early as December: 25 or 50 bp.

According to VTB Capital’s estimates, inflation may be stable at about 4% at a key rate of about 5.5%, but there may be a big error in this estimate - the limit for reducing the rate depends on confidence in the Central Bank’s policy and on volatility and risks in the economy, the chief believes VTB Capital economist for Russia and the CIS Alexander Isakov.

Shibanov suggests that by the end of 2020, in order for inflation to settle at around 4%, a rate of 6-6.25% would be enough.

It’s still difficult to assess the Central Bank’s readiness to switch to stimulating rates below 6% during 2020, argues Polevoy, the predictability of its actions in the medium term is small. Back in September, a decrease of 50 bp. p. looked almost impossible, but at 25 bp. n. - uncertain.

The decision of the US Federal Reserve next week will be important, concludes Tremasov: if it takes a break, then the likelihood of a December rate cut in Russia will decrease.

 

Source: www.vedomosti.ru

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