The Bank of Russia cuts the key rate by 50 b.p. to 8.50% p.a

On 15 September 2017, the Bank of Russia Board of Directors decided to cut the key rate by 50 b.p. to 8.50% per annum. The Board of Directors notes that inflation is close to 4% while the economy keeps growing. Amid favourable price dynamics of a number of goods and services, inflation expectations resumed their decline, though they have not yet anchored at a low level. Medium-term risks of inflation overshooting 4% dominate over the risk of its steady downward deviation from the target. In order to maintain inflation close to 4%, the Bank of Russia will continue to conduct moderately tight monetary policy.

During the next two quarters, the Bank of Russia deems it possible to cut the key rate further. While making its decision hereinafter, the Bank of Russia will assess the risks of inflation’s material and sustainable deviation from the target, as well as consumer price movements and economic activity against the forecast.

In making its key rate decision, the Bank of Russia recognised the factors as follows.

Inflation dynamics. Inflation stays close to 4%. In August, inflation totalled 3.3% following a short-lived rise to 4.4% in June. Inflation continues to decline in the non-food goods market; services price growth has stabilised around 4%. High homogeneity of inflation is maintained for consumer basket and across regions. Food price growth decelerates due to the seasonal cheapening of vegetables and fruit, which has exceeded preliminary estimates.

As inflation becomes lower, the contribution of volatile components, consisting of vegetable and fruit prices, among other things, to the general movement of the consumer price index becomes more pronounced. During 2018 short-term factors may cause inflation to deviate from the 4% both to the upside and to the downside. Noticeable changes in the prices for the consumer goods and services most often purchased by the population feed through to inflation expectations dynamics rather quickly. To keep inflation close to 4%, it is necessary to make inflation expectations less sensitive to price movements.

Monetary conditions. Monetary stance continues to support household propensity to save amid elevated economic activity and recovery in current incomes. Real bank rates remain in positive territory. Nominal lending rates continue to decline influenced by earlier key rate cuts, as well as those expected by market participants. Banks tend to ease non-price lending conditions on a case-by-case basis and continue to thoroughly select borrowers. Conservative approach employed by banks, coupled by moderately tight monetary policy, shapes conditions required for anchoring inflation close to 4% and for the further reduction in inflation expectations.

Economic activity. In Q2, GDP growth exceeded the forecast figures. Economic growth was spurred by investment and consumer demand along with the recovery of production inventories. Higher consumer demand under current monetary conditions does not pose significant inflation risks amid the expanding supply of goods and services. Q2 saw further growth in manufacturing output; construction began to rise. Trade, mining and transport made a major contribution to the accelerating economic growth. Certain industries experienced faster growth due to both persistent and one-off factors that will most likely have less influence during the next six months, which is in part supported by July statistics. In view of the positive trend set by Q2, the forecast for GDP growth in 2017 has been revised upwards to 1.7-2.2%.

The Bank of Russia’s assessment of the medium-term economic development remains the same. The economy is close to its potential. Growth might be constrained by insufficient production capacity together with the possible skilled labour shortages affecting certain segments of the labour market. Further GDP growth above 1.5-2% a year is attainable if structural reforms are put in place.

Inflation risks. Medium-term risks of inflation overshooting 4% dominate over the risk of its steady downward deviation from the target.

Fluctuations of food prices will remain the source of inflation volatility over the next six months. Food price dynamics will depend on the quality and preserved volumes of the harvest. Short-term food market factors might trigger temporary deviation of inflation (both upward and downward) from the 4%, which, however, will not persist.

Key sources of medium-term inflation risks remain unchanged. First, there are potential price fluctuations in global commodity markets. Implementation of the budget rule will reduce risks linked to oil price movements. Second, labour productivity growth may lag considerably behind the wage growth as the structural shortage of labour force aggravates. Third, inflationary pressure may stem from changes in households’ behaviour as the propensity to save becomes much lower. Fourth, inflation expectations remain highly sensitive to changing prices for individual groups of goods and services and exchange rate movements.

These factors call for moderately tight monetary conditions to be kept in place in order to anchor inflation close to the target.

During the next two quarters, the Bank of Russia deems it possible to cut the key rate further. While making its decision hereinafter, the Bank of Russia will assess the risks of inflation’s material and sustainable deviation from the target, as well as consumer price movements and economic activity against the forecast.

The Bank of Russia Board of Directors will hold its next rate review meeting on 27 October 2017. The Board’s decision press release is to be published at 13:30 Moscow time.

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