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Statement by Bank of Russia Governor Elvira Nabiullina in follow-up to Board of Directors meeting on 16 September 2022

16 September 2022

Good afternoon! Today, we have made the decision to decrease the key rate by 50 basis points to 7.50% per annum.

With the key rate at this level, we can say that our monetary policy is currently neutral. We see that one-off disinflationary factors are gradually weakening and proinflationary risks are growing. We believe that we now have less room for reducing the key rate. According to our forecast, inflation will slow down to 5–7% in 2023, considering the uneven influence of the structural transformation. Our monetary policy is aimed at returning annual inflation to 4% in 2024.

I will now explain the reasons behind our today’s decision.

First. Annual inflation is slowing down, but the effect of disinflationary factors will be weakening further on.

The main contributors to the price adjustment in summer were the earlier ruble strengthening, households’ higher propensity to save, and the expanded supply of agricultural products. These are largely one-off factors, and their impact will gradually be diminishing. Current price growth rates will exceed today’s near-zero levels. That said, we do not rule out that annual inflation in the first six months of the next year might temporarily decrease below the target because of the high base effect. In other words, arithmetically, we can get a low rate comparing prices for consumer goods and services in March—April 2023 with prices in March—April 2022 when we observed soaring demand and the surge in prices. In this context, annual inflation will, like a rear-view mirror, reflect the situation of 2022.

In addition to the factors decelerating inflation that I have already mentioned today, the current weak inflationary pressure is associated with the effects of the structural transformation of the economy. Earlier, we said that it was primarily speeding up inflation. Now, we can see that the situation is more complex: the structural transformation might be accompanied with disinflationary processes alike. In particular, the effects of the sanctions on exports and imports might be both proinflationary and disinflationary and change the direction over time.

I would like to explain this in greater detail. Speaking of the sanctions on imports, their initial effect is certainly proinflationary as the economy faces a deficit of the sanctioned goods. However, later on, adjusting factors might arise. Firstly, there are alternative supply channels that are arranged, substituting products, and so on. Progressive restoration of imports smooths the proinflationary effect. Secondly, when sanctions are imposed on a considerable share of imports, the demand for foreign currency inside the country declines and the ruble strengthens, which also causes an adjustment of the initial surge in prices.

In the case of sanctions on exports, the original effect is, on the contrary, disinflationary. Exporters are looking for opportunities to make up for the lost external demand, including by expanding supplies to the domestic market, which puts downward pressure on prices. If sanctions result in a contraction of the inflow of export revenues to the country, this decline partially, through the ruble depreciation, weakens the initial disinflationary effect. Many companies will gradually find new external markets. This factor might both speed up (as companies become more flexible in their pricing policy in the domestic market) and slow down inflation: when the inflow of foreign currency revenues recovers, the exchange rate rises, which has a disinflationary effect.

Summing up, we believe that the structural transformation of the economy will be accompanied with a faster rise in prices, despite some short periods of their adjustment. This is a critical factor that we consider forecasting inflation above the target next year and choosing our monetary policy approach. We have decreased the inflation forecast for this year to 11–13%.

Making our decisions, we rely on the forecast, rather than current inflation trends. The estimate of steady inflationary pressure is of key importance over the forecast horizon. ‘Steady’ means that inflationary pressure is adjusted for seasonal factors and the contribution of the most volatile components distorting inflation trends. Today, this estimate is low, but it is still above zero. I mean median, core inflation and other indicators of inflation adjusted for volatile components.

Further on, steady inflationary pressure might intensify slightly. Among other things, this might be driven by a decrease in households’ propensity to save. Currently, people prefer to save, rather than consume. This is largely explained by high uncertainty, a decline in real incomes, and concerns about future incomes and employment. However, this is partially associated with the so-called forced saving. People could save for large purchases or travel, but were forced not to go ahead with them, as a result of which the unused funds remained in their bank accounts.

If inflation expectations stay elevated, this might shift this behaviour model towards more active consumption. We are concerned about the fact that households’ inflation expectations are still elevated and have even risen slightly, although the overall level of the prices has been decreasing for several months already. This was different over previous periods of inflation deceleration, for instance, in 2019. If the situation in the economy evolves better than expected and people feel more confident in their future incomes and employment, this might also boost consumer activity.

Second. The economic situation is better than expected.

The GDP decline in the second quarter was close to our forecast. Moreover, there are signs that the situation is changing in a slightly more positive way in the third quarter, although it is still very uneven across sectors and regions. The situation in coal production, metallurgy, and forestry is more complicated as the sanctions in these industries significantly hinder companies’ operations. Goods exports to the West have seriously contracted or even become impossible in some cases, whereas goods sale to the East requires a considerable expansion of infrastructure. This will take time.

Nonetheless, importers are adjusting to the changed situation wth greater agility. Importers of domestic appliances and electronics have managed to restore supplies by refocusing on other manufacturers and using parallel import channels. Construction companies have also been able to arrange the supplies of many items, and most agricultural enterprises have managed to find new seed suppliers. More details on these issues are available in our Regional Economy review.

I would briefly talk of the labour market. The situation here remains stable. In recent months, companies have been using part-time employment schemes slightly less frequently. The demand for labour remains steady, although its structure is changing. For instance, companies are importing new equipment, due to which they need specialists who have completed retraining to work on this equipment. The structural transformation of the economy will inevitably cause a dismissal of employees where production becomes economically irrational or a transfer of workforce to industries opening up new opportunities. This might translate into a temporary increase in structural unemployment.

We will factor in all these trends in our updated forecast that we will present in October. The forecast of GDP for this year will most probably improve.

Third. Monetary conditions are currently neutral overall, according to our assessment. 

The structure of household savings with banks is adjusting to the earlier changes in monetary conditions. In spring, the yield curve of federal government bonds was inverted, that is, short-term interest rates were higher than long-term ones, whereas now the curve has normalised. Following this change, deposit rates have also adjusted, which has influenced the structure of household deposits. Specifically, the short-term deposits opened in spring at high interest rates have been transferred to current accounts and longer-term deposits. The structure of savings is thus returning to that observed last year.

Businesses’ and households’ demand for loans is increasing. After a pause in spring, corporate lending is expanding at a high pace. Although subsidised loans continue to play an essential role, market-based lending is becoming more important as it is getting more attractive owing to the considerable reduction of the key rate. Growth in retail lending is mostly driven by mortgage loans. Banks’ risk appetite is recovering, which is also confirmed by a higher percentage of approved applications for unsecured loans.

Overall, monetary conditions have neither a proinflationary nor a disinflationary effect at the moment.  

I would now dwell on the risks for the forecast.

Disinflationary risks might manifest themselves predominantly in the short term. These risks might arise if the pass-through of the earlier ruble appreciation to prices becomes stronger, households’ propensity to save remains at the current level or increases, and exports are redirected to the domestic market. 

As to the medium-term horizon, proinflationary risks still dominate. They include a contraction of foreign currency revenues due to the already announced sanctions. Geopolitical risks remain significant. A worsening of the situation in the world economy might have an additional negative impact.

Consumer activity is a factor of high uncertainty. Elevated inflation expectations are not transforming into a rise in consumer demand at the moment. However, this might change, especially in the situation when inflation expectations are high and unanchored. The scenario where people start to spend their savings faster and take unsecured loans more actively is possible as well.

There might arise additional supply-side problems. Today, we have not yet experienced all the consequences of the restrictions on investment goods imports as the service life of equipment is quite long. Over time, these problems might become more pronounced.

An essential issue for us is the budget. In recent months, budget expenditures have been growing very fast. This might also provoke proinflationary effects.

I would like to focus on the mutual influence of monetary and fiscal policies. A budget deficit, along with credit to the economy, is a channel of money creation. The more money the economy receives through the fiscal channel, the less room there is for a balanced growth of credit to the economy — that is, the growth rate that will not provoke excess inflationary pressure. To contain the expansion of this credit for ensuring low and steady inflation, we will have to set a higher key rate. A long-term shift in fiscal policy towards easing means that the Central Bank will need to maintain a higher level of interest rates to ensure price stability. Therefore, the size of the structural deficit of the budget will influence our assessment of the neutral rate of interest.

Now, I would like to comment on monetary policy prospects. Most likely, the key rate reduction cycle is now close to its end. There are multiple signs suggesting that inflationary pressure is ceasing to weaken. In this context, we believe it reasonable to preserve a neutral monetary policy stance. Considering that the inflation forecast for the next year exceeds the target, we estimate the range of the shorter-run neutral rate above the range of the longer-run neutral rate (which is 5–6%). The monetary policy we pursue is aimed at returning inflation to 4% in 2024.

Thank you for attention.