CBR Maintains Strong Hawkish Stance by Lifting the Rate to 15%
Bottom Line: Central Bank of Russia (CBR) announced on October 27 that it decided to hike the key rate by 200 bps to 15%, citing inflationary pressures remaining high, steadily rising domestic demand, lending growth pace, weakening of the RUB, labor shortages and elevated households’ inflation expectations. Taking into account that CBR continues monetary tightening to cool off inflation, we think this can suppress demand, imports and squeeze lending in the upcoming quarters, but impacts will be seen with time lags. We now foresee the policy rate at 16% by end 2023, as the CBR strongly signaled that tightened monetary policy to limit the upward deviation of inflation from 4% target will continue as long as inflation bites.
Figure 1: $/Ruble, October 2022 - October 2023
Source: Datastream
According to the Monetary Policy press release by the CBR today, CBR remained concerned about multiple issues such as higher inflationary pressure seen across an increasingly broader range of goods and services, growing domestic demand exceeding capacity, weakening of the RUB, labor shortages, elevated households’ inflation expectations and raising businesses’ price expectations. CBR also underlined that it can additionally tighten monetary policy to limit the upward deviation of inflation from the 4% target, signaling tightening cycle has not finished, and updated forecast for the annual inflation to range from 7.0 to 7.5% in 2023.
One striking section of the MPC report was the part on demand-supply dynamics. CBR made detailed explanations on the course of the demand and supply imbalance igniting inflation. First, it appears the growth in domestic demand continues to outpace the supply expansion capacity, intensifying underlying inflationary pressures in the economy. Underscoring the steady growth in domestic demand, CBR mentioned that steep demand has been partly caused by expanding private demand, while public sector demand remained high and fiscal stimulus is now expected to increase again. We understand the consumer activity growth is ignited by surging real wages and strong credit growth. High investment demand has been triggered by the increased profits of companies and positive business sentiment, supported by the fiscal stimulus.
As the demand-supply balance continues to suffer damage, the major supply-side constraint remained the tight labor conditions. While unemployment is at historically low levels, CBR pointed out the poor geographic and cross-sectoral labor force mobility as the additional structural constraints. CBR also emphasized that due to limited labor resources, labor productivity growth lags further behind an increase in real wages.
Buoyant domestic demand continues to contribute to pump up imports triggering the RUB to lose value. RUB plunged to an 18-month low against USD on October 9, exceeding 102.1 level, the lowest since March 2022, led by the ongoing war in Ukraine and the tension between Israel and Hamas, compounded with the decline in energy earnings. Russia’s foreign trade surplus shrank dramatically in January-September 2023 YoY to $87.8 billion while the surplus of the country’s current account also plummeted in the same period to $40.9 billion, showing the deterioration on the trade front. (Note: CBR also acknowledged that high demand for imports coupled with reduced exports is a key factor of the RUB’s depreciation since early 2023). It seems the ongoing war and geopolitical tensions affecting terms of foreign trade also creating proinflationary risks for Russia.
On the monetary policy front, CBR clarified that interest rates have begun rising in the credit and deposit market, and growth in unsecured consumer lending has slowed. On the other side of the medallion, credit activity has remained high in the corporate segment, and mortgage lending continued to expand apace, including due to the large volume of loans issued under government subsidized lending programs.
Under current conditions, we expect inflation will likely continue to bite, while inflationary expectations and currency volatility are predicted to remain despite the tightening cycle resumes. We now foresee the policy rate at 16% by end 2023, as the CBR strongly signaling that it remains dedicated to start the disinflationary process as soon as possible and bring the inflation to target levels, taking into account that the inflation is now forecast by the central bank to reach 7-7.5% by the end of 2023 and RUB continues to plummet.