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Statement by Elvira Nabiullina, Bank of Russia Governor, in followup of Board of Directors meeting 16 June 2017




Today the Bank of Russia Board of Directors decided to reduce the key rate to 9.00 p.a.

Let me set out in further detail factors that were central to our decision.

First, inflation has virtually been at target levels since the start of the year 2017. It is estimated at 4.2%, as of 13 June.

Price movements are increasingly homogeneous across various regions and commodity groups. This suggests that the slowdown in inflation has become more sustainable. This trend is confirmed by core inflation data, more resilient to the impact of one-off factors. Core inflation was 3.8% in May.

A recovery in consumption is becoming progressively more visible. Households are moving to realise deferred demand for durable goods (household appliances and cars). Importantly, households are largely increasing their spending from current incomes rather than from accumulated savings or credit. This is enabled by the moderately tight monetary conditions. Consumer demand continues to exert a disinflationary effect.

Households have nonetheless been saving less out of their current incomes. This is evidenced by a slew of data including those indicating slower growing deposits. At this point in time, this is understood to be a natural trend considering the ongoing economic recovery. We intend to watch these developments carefully, given the potential inflation risks involved.

Second, lower inflation expectations help us anchor inflation close to the target level. As regards households, their inflation expectations touched a new record low in May; however, they are still heightened at 10.3%. Analysts expect on-target 4% inflation in both 2017 and 2018. According to short-term surveys of companies, regularly conducted by the Bank of Russia, corporate inflation expectations are also down; yet they are invariably heightened.

Households’ inflation expectations have yet to show a sustainable downward trend. The way households tend to perceive inflation is determined by, beyond current price movements, price growth over the previous months or even years. This is why we are now increasingly focused on the average annual inflation level for the past 12 months. This value is calculated as an average of the twelve recent annual inflation indicators. This is currently 5.6%. This is to say, inflation having closed in on 4% is seen as an early accomplishment and remains to demonstrate sustainability. As inflation stays close to 4% every next month, the average annual inflation reading will be moving close to this level. It is only at this point in time that we could say that our inflation is low at 4%.

Beyond overall price movements, household inflation expectations are impacted by price fluctuations in individual commodity groups. These are primarily food prices with their inherently higher volatility. And, this impact is asymmetrical in nature. Households tend to take notice of growth in prices, more than their decline.

Lower imports in the food consumer basket help reduce the exchange rate effect on prices. Yet, as import substitution unfolds, intra-year price fluctuations may intensify given the expressed seasonality of Russian agricultural production. Surges in food inflation are most heavily felt by consumers and could undermine the sustainability of the trend towards lower inflation expectations. This is the area where additional government support is needed to develop the appropriate infrastructure, principally, to provide for transportation, storage, processing and sales of agricultural products in order to reduce seasonal price volatility.

Third, the pace of economic recovery has exceeded somewhat our expectations. However, the medium-term outlook for economic growth remains unchanged.

Rosstat’s data suggest that annual GDP growth accelerated in the first quarter. The increase in industrial production and rebound in investment continued. The number of regions displaying production growth increased compared with the last year.

We expect GDP to grow 1.3-1.8% this year. This projection is slightly above the previous baseline forecast. However, we still consider the oil price to stand at $50 a barrel in 2017, given the current price movements and the oil market outlook. The reason behind the upward revision of GDP projections is a somewhat faster-than-expected economic rebound since the start of the year, which came with improving business sentiment.  

We still assume that the oil price will draw back to roughly $40 a barrel in 2018-2019. We do not expect it to considerably affect economic growth given that the economy has already largely adjusted to low oil prices.

As for the balance of payments, we forecast the current account to stay in positive territory at about 1-2% of GDP. Amid the floating exchange rate regime, capital outflow and current account movements will be mutually balanced depending on changes in the international reserves.

Our baseline scenario provides for medium-term economic growth of about 2% given the structural constraints. Growth prospects will increase as the governmental structural policy is implemented. We will be able to consider their impact our forecasts when specific decisions are taken.

Fourth, medium-term inflation risks remain in place. They are as follows.

The external economic situation will likely remain unstable, as confirmed by the volatility of oil prices. We do not rule out that [oil] production in the US will grow and other countries, which are not parties to the agreement, will expand their supplies to the global market. Demand-side risks are also in place. They result from a likely slowdown in the Chinese economy, as well as the development of energy-efficient technologies and alternative energy sources.

As before, our press release traditionally lists another two risk sources - the inertia of inflation expectations and possible fiscal policy revisions.

However, new inflation risks have recently become more evident.

We take into account that increasing consumption and lower propensity to save are natural at this stage. Inflation risks will grow if these processes unfold too fast and outpace the expansion of production. Then inflationary pressure will increase both on domestically produced and imported goods. This will result, among other things, from the exchange rate movements, given that the increased consumption will largely be met through imports.

Unemployment indicators have been relatively low in recent years even as production decreased. Joblessness is in decline. Some segments are already seeing labour shortages. Their aggravation may have two effects. The direct one is the productivity of labour lagging behind the wage growth. The indirect effect is a decline in growth potential due to the impossibility of attracting required specialists to expand production and set up new businesses.

In order to constrain these risks we need not only monetary but also structural policy measures.

To conclude, I would like to reiterate that inflation slowdown to roughly 4% is only the first, though a very important, step towards ensuring price stability.

At this stage, our objective is to anchor inflation close to this level, push inflation expectations further downwards and make them less responsive to unfavourable factors and risks.

It is important that we could build confidence of all economic actors in our capability to anchor inflation close to the 4% target for a long period of time. Therefore, our approach to key rate cuts will remain balanced and prudent.

16.06.2017

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