The Bank of Russia, which had been expected to cut its rate today in light of easing inflation, said inflation has been slower than expected and it is now more confident that it is trending lower.
At its last meeting in April, the bank's board adopted an easing bias by saying it would lower its rate at one of its "forthcoming" meetings if it becomes more confident that inflation is falling.
Illustrating this confidence, the central bank lowered its forecast for inflation to 5-6 percent by end-2016 from a previous forecast of around 6 percent, and to less than 5 percent by May 2017 from April's estimate of about 5 percent in April 2017.
The central bank confirmed that it still expects to reach its 4 percent inflation target in late 2017, and although the risks that it will not reach this target have declined, they remain heightened. Renewed volatility in financial and commodity markets could have a negative impact on the ruble's exchange rate and there is uncertainty surrounding government budges and wage indexation.
But one important reason behind the decision to cut rates was that "positive trends in the economy are not accompanied by a higher inflationary pressure," the central bank said, noting that inflation expectations by households and businesses have continued to decrease.
Russia's inflation rate was been stable at 7.3 percent in May for the third month in a row, helped by a firmer exchange rate of the ruble.
Russia's rouble came under pressure in mid-2014 from the collapse in crude oil prices and the conflict in Ukraine and the imposition of Western sanctions added further pressure, with the ruble depreciating by 18 percent against the U.S. dollar in 2015
But after hitting a low of 82 to the dollar in January, the ruble has strengthened along with the rise in oil prices and was trading at 64.5 to the dollar today, up 13.8 percent since the start of this year.
Russia's economy is also showing signs of pulling out its slump, with the central bank forecasting that Gross Domestic Product will expand "no later than" in the second half of this year on a quarterly basis and GDP will increase by 1.3 percent in 2017 based on what it described as "a fairly conservative estimate" of annual oil prices of around $40 a three-year horizon.
In April the central bank said it first expected positive quarterly growth rates in the second half of this year or early 2017 and in March it forecast that growth would contract by 1.3-1.5 percent this year and be around zero percent in 2017 following 2015's 3.7 percent contraction.
On a quarterly basis, Russia's GDP contracted by 0.57 percent in the third quarter of 2015 from the second quarter and on an annual basis it shrank by 1.2 percent in the first quarter of this year compared with annual fall of 3.8 percent in the previous quarter.
In addition to higher oil prices, the central bank said non-commodity exports and import substitution had continued to expand and addition growth areas in manufacturing were showing up. However, investments are still on a downward trend and a wide range of traditional industries are still experiencing stagnation.
In a separate move, the central bank said it would raise the required reserve ratio on domestic and foreign banks' foreign currency liabilities by 100 basis points to 6.25 percent as of July 1 to discourage banks from lending in foreign currencies.
The reserve ratio on lending in rubles was retained at 4.25 percent though the central bank also said that it was ready to take measures to mop up liquidity in light of "the emerging transition to the banking sector liquidity surplus."
The Bank of Russia released the following statement:
"On 10 June 2016, the Bank of Russia Board of Directors decided to reduce the key rate from 11.00 to 10.50 % p.a. The Board of Directors notes the positive trends of more stable inflation, decreased inflation expectations and inflation risks against the backdrop of imminent growth recovery in the economy. Slowing inflation allows more certain reliance on sustainable inflation reduction to less than 5% in May 2017 and the 4% target in late 2017, taking into account the decision just made and the retention moderately tight monetary policy. The Bank of Russia will consider the possibility of a further rate cut based on estimates for inflation risks and alignment of inflation decline with the forecast trajectory.
In making its key rate decision, the Bank of Russia Board of Directors has proceeded from the following factors.
First. There is more confidence in steadily positive trends in the inflation dynamics. Consumer prices grew less than predicted. The annual inflation has stabilised at 7.3% and the annualised monthly inflation, seasonally adjusted, is about 5%. Economic activity indicators improve along with ongoing low consumer demand and a high rate of savings without creating upward pressure on consumer prices. Inflation expectations of households and businesses continue to decrease. The situation in the global commodity markets was more favourable than expected and contributed to the inflation slowdown through the ruble exchange rate and food price movements (these factors’ influence is temporary and is subject to decrease, which is considered in the inflation forecast). The administered prices and tariffs will be adjusted in July in compliance with the stated plans, but to a lesser extent than a year ago. Consumer price growth rates will keep on going down further, primarily influenced by the demand-side restraints. The Bank of Russia marked down its inflation forecast for the end of 2016, to 5-6%. Considering the decision just made and retaining the current monetary policy stance, the annual inflation will be less than 5% in May 2017 to reach the 4% target in late 2017.
Second. Positive trends in the economy are not accompanied by a higher inflationary pressure. The figures of the GDP dynamics in 2016 Q1 and macroeconomic indicators for April confirm greater sustainability of the Russian economy to oil price fluctuations. Import substitution and non-commodity exports continue to expand and additional growth areas in manufacturing are taking shape. However, the changes in economic dynamics vary across the industries and regions. Investments continue to show a downward trend and a wide range of industries experience stagnation, including those that have traditionally been the sources of growth for the Russian economy. Yet positive shifts in the economy anticipate the beginning of its growth recovery. Quarterly GDP growth is expected no later than 2016 H2. The forecast predicts a GDP increase of 1.3% in 2017 and annual growth rate for output of goods and services remaining low in the following years. The forecast is based on a fairly conservative estimate of the annual average oil price, which is approximately $40 per barrel over the three-year horizon.
Third. Monetary conditions will still be moderately tight, despite a slight easing due to the lowering banking sector liquidity deficit. Real interest rates in the economy (adjusted for inflation expectations) will remain at the level that encourages savings and allows for demand for loans that does not cause an increase in inflationary pressure. In order to ensure operational control over the level and structure of market interest rates in the context of the emerging transition to the banking sector liquidity surplus, the Bank of Russia is ready to take a set of measures designed to mop up liquidity.
Fourth. The risks that inflation will not reach the target of 4% in 2017 declined, but still remain at a heightened level. This primarily stems from inflation expectation inertness, the lack of mid-term budget consolidation strategy and the uncertainty in the parameters of future indexation of wages and pensions. Volatility in the global commodity and financial markets also might have a negative impact on the exchange rate and inflation expectations. The materialisation of these risks might cause a slowdown in the inflation reduction.
The Bank of Russia will consider the possibility of a further rate cut based on estimates for inflation risks and alignment of inflation decline with the forecast trajectory.
The Bank of Russia Board of Directors will hold its next rate review meeting on 29 July 2016. The press release on the Bank of Russia Board decision is to be published at 13:30 Moscow time."
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