Today's guidance by the Bank of Russia is largely identical to its statement from last month when it also said it would maintain its rate this year and first cut it next year to ensure the trend towards a "sustainable decline in inflation to strengthen."
Russia's inflation rate eased to a 2016-low of 6.2 percent as of Oct. 24, down from 6.4 percent in September and 6.9 percent in August but the central bank said this decline was "to a great extent on the back of temporary factors, while the deceleration in inflation expectations remains unsteady."
The central bank is fighting to push down inflation toward its target of 4.0 percent by the end of 2017 and by 4.5 percent by October 2017.
Inflation is being held by back a rise in the exchange rate of Russia's ruble, a good harvest that helped keep food prices in check, while the disinflationary impact of domestic demand is starting to lift, which means there will be a slower decline in non-food prices, the central bank said.
After plunging in 2014 and 2015, the ruble has risen more than the central bank expected this year and was trading at 62.9 to the U.S. dollar today, up 16.7 percent so far this year.
The central bank said its guidance from last month aimed to alter the expectations of investors and households who were looking for a faster pace of rate cuts and a slower decline in inflation that it had forecast.
The central bank's September guidance was party successful - the yield curve shifted upwards and thus maintained tight monetary conditions - but inflation expectations for late 2017 still remain above the central bank's 4.0 percent target.
The central bank said there are still risks that it may not reach its inflation target due to inflation expectations, a possible weakening of households' propensity to save and higher wages. In addition, the government has not yet decided on budget cuts nor an indexation of public sector wages and social benefits, and volatility in global financial and commodity markets could have a negative impact on the exchange rate and thus inflation expectations.
"The Bank of Russia estimates that moderately tight monetary conditions do not hinder economic recovery, with structural factors being the main restrictions,' the central bank said.
While there are signs that Russia's economy is adjusting to a new environment of low oil prices and the fall in the ruble that is resulting in import substitution and growth in some high-tech sectors, overall investment activity is "persistently weak" and several industries are stagnating or declining.
"Positive trends need time to develop and root," the central bank said, forecasting that overall output this year will decline by 0.5-0.7 percent, though the fourth quarter will witness "slight quarterly growth" and growth next year will be below 1 percent.
Russia's Gross Domestic Product shrank by an annual 0.6 percent in the second quarter of this year, down from a decline of 1.2 percent in the first quarter for the sixth consecutive quarter of contraction.
The Bank of Russia issued the following statement:
"On 28 October 2016, the Board of Directors of the Bank of Russia decided to keep the key rate at 10.00 per annum. The Board of Directors notes that the dynamics of inflation and economic activity are overall in line with the forecast. At the same time, inflation is slowing down to a great extent on the back of temporary factors, while deceleration in inflation expectations remains unsteady. For the trend towards inflation slowdown to become sustainable, according to Bank of Russia estimates, it is necessary to hold the current key rate throughout 2016, with its potential downgrades due in 2017 Q1-Q2. Given this decision and considering that the moderately tight monetary policy is maintained, annual growth in consumer prices is set to total less than 4.5% for October 2017, dropping to the target level of 4% by the end of 2017. When making its key rate decisions in the months ahead, the Bank of Russia will assess inflation risks alongside with the alignment of inflation dynamics and economic performance with the baseline forecast.
In making its key rate decision, the Bank of Russia Board of Directors was guided by the following considerations:
First. Annual inflation continues its decline in line with the Bank of Russia’s baseline forecast; however, this is largely due to temporary factors. Estimates as of 24 October indicate that annual consumer price growth was down to 6.2% from 6.4% seen in September. A meaningful contribution to the inflation reduction is made by the performance of the ruble exchange rate as oil prices have been higher than expected and Russian financial assets are becoming more attractive to external investors. Also, the good harvest helped lower food price growth. The disinflationary impact of domestic demand is however going down, which translates into slower deceleration of non-food product prices. Households have thus far been abiding by a saving-oriented model of behaviour. However, tentative signs of rising real wages may contribute to a gradual recovery in demand for goods and services. The key rate held at the current level long enough is expected to determine monetary conditions further on, which are critical to support incentives to save and shore up the trend towards sustainable inflation reduction, impacted by demand-side constraints. This will enable a further decline in inflation expectations. Considering the decision made and the maintenance of moderately tight monetary policy, the Bank of Russia forecasts that annual inflation will stand at less than 4.5% in October 2017, thereafter reaching the 4% target by late 2017.
Second. The further path of the key rate outlined by the Bank of Russia in September sought to adjust expectations of market participants, who forecast faster key rate reduction and slower inflation decline than predicted by the Bank of Russia. The announcement shifted the yield curve upwards in the financial market and preserved moderately tight monetary conditions. However, inflation expectations of market actors for late 2017 hold above the Bank of Russia’s 4% inflation target. The correction of the level of interest rates in the financial market was responsible for preserving moderately tight monetary conditions, expected to remain in the economy long enough. Positive real interest rates will be held at a level which, while securing demand for credit, will exclude heightened inflationary pressure and keep incentives to save. Tentative signs of recovery in consumer lending do not bear substantial inflation risks so far given that a considerable part of current loans is used to refinance previously extended loans.
Third. The revival of production remains unstable and varies across industries and regions. The Bank of Russia estimates that moderately tight monetary conditions do not hinder economic recovery, with structural factors being the main restrictions. The labour market is adjusting to the new economic environment, and unemployment remains stable and low. Import substitution is progressing and certain items of non-commodity exports show an upward trend. Industry, including high-tech production, finds new growth factors. However, they are still unable to ensure that overall production dynamics remains sustainably positive. At the same time, individual industries are stagnant or show lower output growth. The emerging signs of recovery in investment activity are persistently weak. Positive trends need time to develop and root. The year 2016 will see an overall 0.5-0.7% drop in the output of goods and services, while the fourth quarter is expected to post a slight quarterly growth. In 2017, economic growth will be low (under 1%). This forecast is based on conservative assumptions about low growth of the global economy, average oil prices of about $40 per barrel, moderate capital outflow, and persistent structural restrictions of Russian economic development.
Fourth. Risks remain that the 4% inflation target may not be reached in 2017. This mainly results from inertial inflation expectations, possible weakening of households’ propensity to save, and higher real wages not supported with a rise in labour productivity. No legislative decision has yet been taken with regard to specific medium-term fiscal consolidation measures, including the indexation of wages in the public sector and social benefits. Volatility of global commodity and financial markets may also have a negative impact on exchange rate and inflation expectations.
The Bank of Russia estimates that the key rate needs to be maintained at the current level until the end of 2016 and can be cut in 2017 Q1-Q2 to anchor the downward inflation trend. The Bank of Russia will assess inflation risks and compliance of economic performance and inflation with the baseline scenario when it makes its key rate decision in the upcoming months.
The Bank of Russia Board of Directors will hold its next rate review meeting on 16 December 2016. The press release on the Bank of Russia Board’s decision is to be published at 13.30 Moscow time."
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