Statement by Bank of Russia Governor Elvira Nabiullina in follow-up to Board of Directors meeting 7 February 2020

Today, the Board of Directors has decided to cut the key rate by 25 bp to 6.00% per annum.

We hold open the prospect of key rate reduction at the upcoming meetings, if the situation develops in accordance with our baseline forecast.

When taking our decision today, we took into account a wide range of factors.

First. Inflation dynamics.

In January, annual inflation declined to 2.4%. Let me remind you that it was 3% by the end of 2019. The inflation slowdown itself vs the December reading was expected and was mainly related to the factoring out of the VAT rate hike from the calculation last year. However, inflation showed a more considerable decline than we had expected.

The seasonally adjusted monthly inflation rate also indicates a low inflationary pressure. Core inflation and other stable price dynamics indicators are close to 3% or lower in annual terms.

We expect that, in the first quarter, annual inflation will reach about 2%. In the middle of the year, it will begin to rise, gradually returning to the target. We maintain our inflation forecast for 2020 at 3.5-4%.

Now, let me speak about the drivers behind current inflation dynamics and why we think that it will return to the target.

Economy's demand. Although we recorded an increase in domestic demand in the second half of the last year, external demand remained quite subdued. Among other things, this resulted in a decline in Russian exports. That said, the dynamics of domestic demand in 2019 were very irregular. Weak demand in the first half of the year led to a fast inflation slowdown to the current low level. The revival in domestic demand in the second half of 2019 and its further expansion this year will become the main driver behind the return of inflation to the target.

Both consumer and public demand has improved. Private consumption growth was driven by increasing real wages and disposable income, including due to falling inflation. The end of the last year also saw a rise in public expenditures and a more extensive usage of funds to implement national projects. In our opinion, these trends will continue this year.

I think it’s important to particularly note the following. From 2015 to 2019, the macroeconomic policy—both monetary and fiscal—was largely determined by the necessity to adapt our economy to the dramatic changes in external conditions that took place in 2014. By the need to increase macroeconomic stability, price stability and fiscal sustainability, to lower the dependency of the economy on the situation in commodity markets and geopolitical risks.

As of today, this goal has been largerly accomplished. The period of adaptation has ended. Budget consolidation has completed, and there is even some space for the accommodative fiscal policy.

Annual inflation has reached the target and since 2017 has averaged 3.7%. It was already last autumn that we completed the transition from a moderately tight to neutral monetary policy.

We cannot afford treating last five years’ achievements recklessly. These achievements have established a foundation to implement an effective countercyclical economic policy.

It is important to note that the effect of the fiscal and monetary policies will largely depend on the behaviour and sentiment of private business and households. It will depend on their response to the decline in interest rates, their use of additional income (whether they will save or spend it) and on whether private investment will grow in response to the budgetary impulse. And this, in turn, depends heavily on the sentiment of producers and consumers, their confidence in the future, their investment horizon, personal plans and the business climate in general. If the sentiment remains cautious, moderate, both fiscal and monetary policy measures will only have a limited effect on the expansion of aggregate demand and sustainable economic growth.

Back to the current situation. Exchange rate dynamics are yet another driver behind the deviation of inflation from the target and subsequent return to it. Last year, the ruble significantly appreciated, and today we still see the accumulated effect of this appreciation. Even with the January fluctuations factored in, the ruble remains stronger than in the previous year. In the first half of the year, the effect of the last year’s appreciation and its disinflationary influence will be exhausted.

Food markets. We are observing price dynamics that are not typical for this time of the year. Seasonally adjusted food prices have basically remained at the same level for several months without growth. The supply factor and the successful developments of our agricultural sector play an important role here. It is difficult to estimate the proportion of temporary and persistent factors in the food market reliably. There remains a potential for further production growth and capacity expansion. At the same time, this sector’s export capabilities are also expanding. Production growth leads to increased competition. We base our view on the fact that this will gradually result in the aligning of food price dynamics with those of other goods and services.

Inflation expectations. No significant changes have been observed here in the recent months. Over the one-year horizon, analysts’ expectations are forming close to 4%. Short-term price expectations of businesses have stabilised at an all-time low levels. Households’ inflation expectations are currently holding close to the two-year minimum. However, we continue to estimate this level as increased. The main thing is that we are yet to estimate the anchoring of inflation expectations of both households and businesses when the slowdown of inflation ends and it returns to the target.

Economic growth dynamics are the second most important factor behind our decision besides inflation.

In 2019, GDP grew by 1.3%, which is the upper bound of our forecast range. Internal consumption growth slightly overshoot our expectations whereas external demand was weaker. As I have already noted, the growth of demand and other economic activity indicators occurred in the second half of the last year, including owing to the accelerated budget execution.

The Board of Directors retained almost the same view for 2020 and medium-term forecast at this meeting. This year, economic growth will exceed the last year’s reading and reach 1.5–2%. This will also drive inflation back to the target. We expect that the growth rate of households’ consumption will remain at the current level while investment growth will notably accelerate. The effect of fiscal measures on the forecast may be clarified after the introduction of amendments to the budget by the Government. Regarding external demand, the forecast implies that exports will recover after the last year’s decline. However their dynamics will be contained by moderate global economic growth rates. In our view, the global economy can be affected by the next phase of trade negotiations as well as the further development of the coronavirus situation. At the moment, we estimate its influence as temporary.

Third. Monetary conditions. They have been generally easing.

This fully refers to price lending conditions. Yields of federal government bonds stay at their lows for the last few years. Interest rates in the deposit and credit market continue to go down. The average interest rate on housing mortgage loans hit its new low in December, dropping to exactly 9% per annum. There is room for further decrease in interest rates owing to the earlier key rate decisions.

However, non-price conditions have been changing in diverse manner. In consumer lending, they have been tightening, which is associated with the macroprudential measures implemented by the Bank of Russia. I would like to remind that these are targeted measures we are taking to maintain financial stability in individual segments of the financial market. In this situation, the growth of consumer lending is slowing down, and this trend will continue.

At the same time, there is a potential for easing of non-price conditions in the corporate segment. This is already happening at the moment. Areas of lending to corporate borrowers are expanding; long-term loans are becoming more affordable, including owing to the development of the bond market. This is also driven by the gradual improvement of the loan servicing quality.

Fourth. There have been some changes in external conditions. But our opinion regarding their overall impact has generally remained the same. China and the USA have signed a trade agreement. This means that the significant risks we saw in foreign trade have not materialised. This positive news supported market sentiment.

Yet, new challenges have emerged and they involve new risks to global economic growth. The coronavirus problem is already affecting the economic situation in both individual countries and the world in general. Speaking of Russia, its influence on our economy is currently estimated as minor.

The reaction of the ruble exchange rate to a substantial decline in oil prices in January and early February and increased volatility in foreign financial markets was moderate. The country risk premium for Russian assets is currently close to its record lows, after its persistent and significant decrease last year. This trend is supported by macroeconomic stability, primarily the accumulated safety cushion in the form of the National Wealth Fund.

Finally, regarding inflation risks.

First, I would like to remind you what we call ‘risks for inflation’, or ‘inflation risks’. The Bank of Russia’s baseline forecast implies a certain path for inflation to return to the target. When we are talking of risks, we mean the reasons that may cause inflation to deviate from the forecast path upwards or downwards. These are proinflationary and disinflationary risks respectively.

Currently, disinflationary risks significantly prevail over the short-term horizon.

First and foremost, this is how demand is changing in the domestic market, both among consumers and investors. An increase in consumption and investments may be lower than we expect, even in the situation of the continuing easing of monetary conditions and accommodative monetary policy. This scenario is possible if there are no marked positive changes in business and consumer sentiment.

Another short-term disinflationary risk is a more considerable and longer-term impact of the ruble appreciation last year, than it was assumed in our baseline forecast.

In addition, there is a range of factors related to both disinflationary and proinflationary risks. One of them is food prices which are very volatile. External conditions are another factor. If the coronavirus situation deteriorates or any complications arise at next stages of the trade negotiations between the USA and China, this can lead to a rise in volatility in financial and commodity markets, a capital outflow and pressures on emerging market currencies, which are proinflationary factors. At the same time, worsening of the situation in the global economy against this background, a decline in external demand for Russia, a slower inflation growth in Russia’s trade partners may ultimately become a considerable disinflationary factor.

The nature of influence of fiscal policy on inflation will depend on the pace and efficiency of the implementation of the planned measures over the forecast horizon.

As before, we can say that unanchored inflation expectations may also be considered a proinflationary risk.

Besides, previous decisions to cut the key rate may have a stronger upward effect on inflation than we estimate in the baseline forecast.

Given the above, we currently estimate mid-term risks for our inflation forecast as balanced.

And to conclude, a few words about the outlook for monetary policy.

Given the today’s key rate decision, we have reached the lower bound of the 6-7% range which we consider neutral for the inflation target around 4%. I would like to emphasise once again that, as such, the neutral rate of interest is not observed directly, it may be determined only approximately. Besides, it may change in time under the influence of various factors. We have yet to estimate and, possibly, adjust this range. Objectively, today we still lack sufficient data for this. It will require a longer period of time, maybe even more than a year.

But what is important to stress today when the key rate is at the lower bound of the range that we have estimated. These bounds, both the upper and the lower ones, do not in any way set any thresholds for possible movements of the key rate, whether upwards or downwards. If our estimate of inflation and the economic situation require, the key rate may be set beneath the lower bound of the neutral range. This will mean loose monetary policy. Similarly, when inflation significantly deviated upwards from 4%, we maintained the key rate above the upper bound of this neutral range for a long period of time.

We hold open the prospect of key rate reduction at the upcoming meetings, if we consider it necessary to bring inflation back to the target, that is close to 4%.

7 February 2020

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