It is Bank of Russia's second rate cut this year following a similar cut rate in June, with the central bank saying inflation is continuing to slow while economic growth is lower than expected.
"Weak economic activity, along with temporary factors, limits inflation risks over the short-term horizon," the central bank said, confirming it expects inflation to return to its target of 4.0 percent in early 2020.
Earlier this month Elvira Nabiullina, central bank governor, told Reuters the bank would like to complete its easing cycle by mid-2020 by trimming the rate in small steps after saying in June that one of two rate cuts were possible by the end of this year.
Nabiullina estimates monetary policy will be neutral when the rate reaches a range of 6.0 to 7.0 percent.
Russia's central bank embarked on an easing cycle in January 2015 as it slowly rolled back a sharp 750 basis point rate hike in December 2014 to protect the ruble, which plunged in the wake of a conflict with Ukraine.
Between January 2015 and April 2018 the key interest rate was cut by a total of 9.75 percentage points as inflation began to ease and the ruble slowly firmed but the easing cycle came to a sharp halt when fresh sanctions by the United States over Russia's meddling in the U.S. 2016 presidential election triggered a 10 percent plunge in the ruble and a 9 percent fall in Moscow stock market.
In September and December, 2018 Russia's central bank then raised its rate twice by a total of 50 basis points in proactive moves to curb inflation from a combination of higher import prices from the lower ruble and a rise in value-added-taxes to 20 percent on Jan. 1, 2019.
After steadily rising in the second half of last year, inflation in Russia peaked in March this year at 5.3 percent and eased further to 4.7 percent in June and was close to 4.6 percent as of July 22 as inflation continues to follow the bank's expected path.
Core inflation also declined in June for the first time since March 2018 to 4.6 percent as consumer demand constrains inflation along with the rise in the ruble this year and lower vegetable prices.
While inflation expectations among businesses have declined, the central bank said households' inflation expectations had not changed materially since April and remain elevated. However, it expects a continued decline in inflation to pave the way for lower expectations.
"Disinflationary risks exceed pro-inflationary risks over the short-term horizon," the central bank said, pointing to weak domestic and external demand.
Growth in Russia's economy has been slower due to weak investment and a drop in exports and a rise in industrial output in the second quarter may not be steady, the bank said.
In the first half of the year fiscal policy also constrained economic activity but the central bank expects government spending to rise in the second half, adding "the risk of a slowdown in global economic growth still looms," in the event of a further tightening of trade restrictions.
Russia's gross domestic product slowed to annual growth of 0.5 percent in the first quarter of this year from 2.7 percent in the fourth quarter of last year.
The ruble has been steadily appreciating since September last year and was trading at 63.15 to the U.S. dollar today, up 10.3 percent this year and up 26 percent since record lows around 80 to the dollar in February 2016.
The Bank of Russia issued the following press release:
"On 26 July 2019, the Bank of Russia Board of Directors decided to cut the key rate by 25 bp to 7.25% per annum. Inflation slowdown is continuing. At the same time, inflation expectations remain elevated. Russian economy’s growth rate is coming in lower than the Bank of Russia’s expectations. Weak economic activity, along with temporary factors, limits inflation risks over the short-term horizon. According to the Bank of Russia’s forecast, taking into account the pursued monetary policy, annual inflation will return to 4% in early 2020.
If the situation develops in line with the baseline forecast, the Bank of Russia admits the possibility of further key rate reduction at one of the upcoming Board of Directors’ meetings and a transition to neutral monetary policy in the first half of 2020. In its key rate decision-making, the Bank of Russia will take into account actual and expected inflation dynamics relative to the target and economic developments over the forecast horizon, as well as risks posed by domestic and external conditions and the reaction of financial markets.
Inflation dynamics. Inflation slowdown is continuing. Annual consumer price growth rate declined to 4.7% in June (from 5.1% in May 2019) and was close to 4.6% according to the estimates as of 22 July. June results show that annual core inflation declined for the first time since March 2018 and reached 4.6%. Seasonally adjusted monthly consumer price growth rate slowed down to 0.1% in June vs 0.3-0.4% in February-May. According to Bank of Russia estimates, most monthly inflation indicators reflecting the most sustainable price movements are close to 4% (annualised).
Consumer demand trends constrain inflation. Temporary disinflationary factors also contributed to slowing consumer price growth, including ruble appreciation since the beginning of the year and the decline in fruit and vegetable prices on the back of early new harvest arrival. Annual inflation dynamics were also influenced by base effects.
In June and July, business price expectations continued to decline. Households’ inflation expectations have not materially changed since April and remain elevated. Inflation slowdown paves the way for a future decline in inflation expectations.
According to the Bank of Russia’s forecast, taking into account the pursued monetary policy, annual inflation will return to 4% in early 2020.
Monetary conditions. Monetary conditions continued to ease since the last Board meeting. Among other things, this was driven by the change in expectations of financial market participants with regard to the Bank of Russia’s key rate path and the downward revision of expected interest rate paths in the US and the euro area. OFZ yields and deposit interest rates continued to decline. The Bank of Russia’s decisions to cut the key rate and the decline in OFZ yields observed since the beginning of this year create conditions for the decrease in deposit and lending rates in the future.
In June, real sector lending continued to grow on the back of eased monetary conditions. Annual growth rate of loans to non-financial organisations reached the maximum level since 2015 while the growth rate of household loans stabilised after a tangible increase in the previous months.
Economic activity. Russian economy’s growth rate since the beginning of the year has been lower than the Bank of Russia’s expectations. This was caused by weak investment activity dynamics and a significant drop in annual export growth rates, including on the back of weaker external demand. The second quarter saw an increase in annual industrial production growth, which may not be steady. Retail trade turnover growth continued to decline YoY amid falling real disposable household incomes. Unemployment remains at the historic lows. However, given the contracting number of employees and the labour force, it does not create any additional inflationary pressure.
In the first half of the year, fiscal policy had additional constraining effect on the economic activity, which is in part related to the shift of implementation schedule of a number of national projects planned by the Government. Since the second half of 2019, government spending, including investment expenditures, is expected to rise.
Inflation risks. Disinflationary risks exceed pro-inflationary risks over the short-term horizon. This is primarily related to the weak dynamics of domestic and external demand.
That said, significant risks are posed by elevated and unanchored inflation expectations. The risk of a slowdown in global economic growth still looms caused, among other things, by the further tightening of international trade restrictions. Geopolitical factors might lead to strengthened volatility in global commodity and financial markets, affecting exchange rate and inflation expectations. Supply-side factors in the oil market may amplify volatility of global oil prices. However, the revision of interest rate paths in the US and the euro area in June and July reduces the risks of considerable capital outflows from emerging markets.
Fiscal policy may cause a meaningful impact on inflation dynamics over both the short- and medium-term horizons. The catch-up growth of budget spending in the second half of the current year may have a pro-inflationary effect in late 2019 — early 2020. Moving on, potential decisions on the use of the liquid part of the National Wealth Fund in excess of the threshold level set at 7% of GDP may exert upward pressure on inflation.
The Bank of Russia leaves mostly unchanged its estimates of risks associated with wage movements, prices of individual food products, and possible changes in consumer behaviour. These risks remain moderate.
If the situation develops in line with the baseline forecast, the Bank of Russia admits the possibility of further key rate reduction at one of the upcoming Board of Directors’ meetings and a transition to neutral monetary policy in the first half of 2020. In its key rate decision-making, the Bank of Russia will take into account actual and expected inflation dynamics relative to the target and economic developments over the forecast horizon, as well as risks posed by domestic and external conditions and the reaction of financial markets.
The Bank of Russia Board of Directors will hold its next rate review meeting on 6 September 2019. The press release on the Bank of Russia Board decision and the medium-term forecast is to be published at 13:30 Moscow time."
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