The Bank of Russia keeps the key rate at 7.75% per annum

On 8 February 2019, the Bank of Russia Board of Directors decided to keep the key rate at 7.75% per annum. In January 2019, annual inflation held at the lower bound of the Bank of Russia expectations. Inflation expectations of households and businesses increased somewhat. The contribution of the VAT increase to annual consumer price growth in January was moderate. The effect of the VAT increase on inflation can be fully assessed no sooner than this April. There persists uncertainty over future external conditions and certain food price dynamics. The balance of risks remains skewed towards pro-inflationary risks, especially over a short-term horizon. Given the decision taken, the Bank of Russia forecasts annual inflation to range between 5.0 and 5.5% by the end of 2019 and return to 4% in the first half of 2020.

In its key rate decision-making, the Bank of Russia will determine if the increases of the key rate in September and December 2018 were sufficient to bring annual inflation back to the target in 2020, taking into account inflation and economic performance against the forecast, as well as the risks associated with external conditions and financial markets’ response to them.

Inflation dynamics. In January 2019, annual inflation held at the lower bound of the Bank of Russia expectations. Annual consumer price growth rose to 5.0% in January (vs 4.3% in December 2018). The contribution of the VAT increase to annual consumer price growth in January was moderate. The effect of the VAT increase on inflation can be fully captured no sooner than this April. Faster growth of food prices to 5.5% (vs 4.7% in December 2018) played a significant role in the inflation rise in January. The acceleration of food inflation is substantively attributable to the recovery after its considerable drop in the second half of 2017 and the first half of 2018. Furthermore, prices are completing their adjustment to the ruble’s weakening of the second half of 2018. Annual inflation of prices of non-food goods and services was below that of food prices during the last 12 months.

In January, price expectations of businesses increased on the back of the earlier weakening of the ruble and the VAT increase. Household inflation expectations rose only slightly.

According to the Bank of Russia forecast, the VAT increase and the 2018 weakening of the ruble will temporarily accelerate annual inflation, which will peak in the first half of 2019 and run at 5.0-5.5% by the end of 2019. Quarterly year-on-year consumer price growth is set to decelerate to 4% as early as the second half of 2019. Annual inflation will return to 4% in the first half of 2020 when the effects of the ruble’s weakening and the VAT rise peter out.

Monetary conditions. Monetary conditions have seen no significant changes since the last Board meeting. Interest rates in individual segments of the domestic financial market have showed mixed trends. OFZ yields have declined as external financial markets regained a stable footing. Interest rates in the deposit and credit market have risen slightly. Sustained positive real interest rates are set to support the attractiveness of bank deposits and bonds and balanced growth in consumption.

Economic activity. Rosstat’s flash estimate shows that 2018 GDP growth totalled 2.3%, which exceeds the Bank of Russia’s forecast of 1.5-2%. However, recent months have seen slower growth in economic activity. December recorded a decline of growth rates in industrial production, construction volumes, real wages and retail sales. The Bank of Russia maintains its 2019 GDP growth forecast in the range of 1.2-1.7%. The VAT increase might have a slight constraining effect on business activity, mostly early in the year. The newly received budgetary funds will be used to raise government spending including investment as early as 2019. Subsequent years might see higher economic growth rates as the planned structural measures are implemented.

Inflation risks. The balance of risks remains skewed towards pro-inflationary risks, especially over a short-term horizon, driven by the VAT increase and price movements in individual food products. Uncertainty remains over future external conditions and their impact on financial asset prices. Despite the oil price growth in January 2019, the risks of supply exceeding demand in the 2019 oil market remain high.

The revisions of the expected paths of monetary policy tightening by the US Federal Reserve and other central banks in developed markets reduce the risks of persistent capital outflows from emerging markets. At the same time, geopolitical factors might lead to strengthened volatility in commodity and financial markets, affecting exchange rate and inflation expectations.

The Bank of Russia leaves mostly unchanged its assessment of risks associated with wage movements, possible changes in consumer behaviour and budget expenditures. These risks remain moderate.

In its key rate decision-making, the Bank of Russia will determine if the increases of the key rate in September and December 2018 were sufficient to bring annual inflation back to the target in 2020, taking into account inflation and economic performance against the forecast, as well as the risks associated with external conditions and financial markets’ response to them.

The Bank of Russia Board of Directors will hold its next rate review meeting on 22 March 2019. The press release on the Bank of Russia Board decision is to be published at 13:30 Moscow time.

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