Inflation Alarming: Russia’s Inflation Surged to 5.2% in August
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Bottom Line: Russian inflation continued its increasing pattern in August as Russia’s Federal Service for State Statistics (Rosstat) announced on September 8 that the annual inflation stood at 5.15% yoy. Taking into account that CPI recorded 4.3%, 3.25%, and 2.5% in July, June, and May, respectively, the data clearly show the upward trend. We believe the reasons behind the surge has been continued Rouble weakening, increased demand for imports, elevated inflation expectations, high domestic demand and lending, strong government spending, strained labor market, and demand - cost pressures in addition to risks posed by the war and sanctions. We think end year key rate will be 14% from the current 12%.
Figure 1: CPI (%, YoY), January 2021 - August 2023
Source: Datastream, Continuum Economics
According to Rosstat, food prices rose by 3.58% in annual terms, while prices of non-food products soared by 1.14% on a monthly basis and by 3.5% compared to August 2022. The cost of services surged by 9.54% in annual terms. Diesel fuel prices hiked by 4.1% and motor gasoline prices added 2.5% YoY. Consumer prices went up 0.6% on a monthly basis.
We think the inflationary pressure stayed strong in August particularly due to a weakening Rouble, and demand-cost pressures stemming from high demand and lending. Despite Central Bank of Russia (CBR) hiking the key rate by 350 bps to 12%, it appears this strong hawkish move could not reverse the weakness of the rouble (here). The dollar exchange rate exceeded 98.5 rubles again as of September 7, after the currency bounced following August 15 rate rise, going up to 92.55. Despite relatively high oil prices and rate hikes, the rouble continues to remain weak and strongly igniting inflationary pressures.
On this matter, Deputy Central Bank Governor Alexei Zabotkin recently told the media that the reasons why the currency has been weakening despite a high oil price are the increased demand for imports, supported by lending. Zabotkin also noted on September 5 that "Proinflationary risks continue to be significant. We will revise our forecast, and an updated forecast will be published following the meeting on September 15, on which the decision will be based. We are not ruling out the possibility of raising the key rate on September 15." Similar to Zabotkin, Governor of the Bank of Russia Elvira Nabiullina said on September 1 that "At the Bank of Russia's Board of Directors meeting on August 15, we gave a neutral signal. In essence, it means both the possibility of keeping the rate unchanged and the possibility of hiking it in the future in order to meet our 4% inflation target in 2024."
As the August inflation is now inside the range of CBR's forecast of 5.0-6.5% range, and economists polled by Reuters expect the inflation to hit 6.5% by year-end, which are well above CBR’s 4% target, we think CBR can hike the rate on the next MPC meeting scheduled on September, 15, particularly if the rate touches 100 again. We are forecast an 50bps hike to 12.5%. This possibility stiffens taking into account that the ruble continues to lose value recently.
In the meantime, CBR announced on September 6 that between September 14 and 22 it would sell each day 21.4 billion rubles ($218.5 million) of foreign currency on the market, about 10 times the current volume it is selling on a daily basis. According to the Bank, the additional volume "will help respond to possible additional demand for foreign currency and reduce volatility on the market during this period." In addition to this, CBR announced on September 7 that it has renewed restrictions on foreign cash withdrawals for six months more, until March 9, 2024.
Despite these actions showing CBR’s determination, cooling off inflation will not be straightforward. Deputy Governor Zabotkin said that the shift to a lower inflation target in Russia from the current 4% will take several years, while the Bank is not considering the possibility of raising the inflation target as it will be perceived both by citizens and business as a price stability threat.
It is obvious that the biggest concern of CBR remains as the steep upward trend in inflation, particularly propped up by both buoyant public sector and consumer demand. Taking into account that the government spending remains high due to war-related military expenses, this triggers inflation to soar as well. Despite CBR having announced its actions to curb demand, inflation expectations continue to remain high and are unanchored in 2023 so far.
Because of these developments, we foresee that further hikes in the policy rates are most likely in 2023, as strongly signalled by CBR. We think end year key rate will be 14% since inflationary expectations and currency volatility are predicted to remain strong, while tighter monetary policy is required to cool off the inflation further considering inflation may quickly deviate from the target in the current framework. We believe that the tightening process will encourage banks to slow loan growth by adjusting their credit and deposit rates and in turn slow private consumption and limit imports, but this will take time.