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On 19 June 2020, the Bank of Russia decided to cut the key rate by 100 bp to 4.50% per annum. Disinflationary factors have been more profound than expected due to a longer duration of restrictive measures in Russia and across the world. The effect of short-term pro-inflationary factors has been largely exhausted. Financial stability risks related to the situation in global financial markets have declined. Household and business inflation expectations have abated. In these circumstances, there is a risk that in 2021 inflation might significantly deviate downwards from the 4% target. The key rate decision taken by the Bank of Russia is aimed at limiting this risk and maintaining inflation close to 4%.

If the situation develops in line with the baseline forecast, the Bank of Russia will consider the necessity of further key rate reduction at its upcoming meetings. 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 this year and in the first half of 2021 will be largely influenced by a steep decline in domestic and external demand occurred in the second quarter. The disinflationary effect of weak demand has strengthened due to both current and deferred economic effect of restrictions. Household and business inflation expectations have abated after a short-lived growth in March-April.

The influence of the weaker ruble and the episodes of increased demand for certain product groups in March has been exhausted. According to preliminary data as of 15 June, annual consumer price growth rate was around 3.1%. In the coming months, consumer price dynamics will be additionally contained by the strengthening of the ruble observed in May — early June on the back of stabilising global financial markets and growing oil prices. Current monthly annualised inflation will continue to decline. At the same time, annual inflation rate will rise in 2020 owing to the low base effect of 2019. 

In the context of prevailing disinflationary factors, there is a risk that in 2021 inflation might significantly deviate downwards from the 4% target. The key rate decision taken by the Bank of Russia is aimed at limiting this risk and maintaining inflation close to 4%.

Monetary conditions slightly eased in May-June after some tightening in March-April. OFZ and corporate bond yields dropped below the levels observed at the beginning of the year, including owing to the current monetary policy stance. The country risk premium went down, largely owing to an improved situation in global financial and commodity markets. Interest rates on deposit and housing mortgage loans decreased. At the same time, increased credit risks in the real sector push interest rates up and lead to a tightening of non-price lending conditions in certain market segments. The Bank of Russia’s decisions to cut the key rate, along with a notable drop in OFZ yields, pave the way for reduction in interest rates in other financial market segments in the future. Coupled with the Government and other Bank of Russia’s measures, this will support lending, including in the most vulnerable sectors of the economy.

Economic activity. Some of the previously enforced restrictive measures remain in place. Alongside a considerable drop in external demand, the negative pressure this is exerting on economic activity is more extended than the Bank of Russia assumed in April. There was a significant drop in business activity in the services sector and manufacturing; a sizeable contraction was reported in the numbers of new orders in external and domestic markets; investment declined. Unemployment went up and incomes shrank. There was a considerable drop in retail sales. The phased lifting of restrictions between May and June is helping consumption-oriented sectors gradually recover. However, recent business surveys invariably reflect cautious sentiment.

The contraction of GDP in the second quarter could prove more sizeable than expected. At the same time, the Russian economy is gaining support from the Russian Government and the Bank of Russia’s additional measures aimed at the mitigation of economic effects of the coronavirus pandemic. In these conditions, GDP will decrease by 4-6% in 2020. Recovery growth of the Russian economy will continue in 2021-2022.

Inflation risks. Disinflationary risks prevail over pro-inflationary ones. Under the baseline scenario, disinflationary risks are chiefly connected with uncertainty as to further developments in the coronavirus pandemic situation in Russia and globally, the scale of possible measures to fight it and their impact on economic activity, as well as the speed at which both the global and Russian economies will recover as restrictive measures are mitigated.

The short-term pro-inflationary risks connected with a potential sizeable pass-through into prices of the recent ruble weakening as well as with the episodes of increased demand for several product groups have all been exhausted. However, disrupted supply chains as a result of the curbs and the additional costs of protecting personnel and consumers from the coronavirus spread could exert upward pressure on prices. The periods of strengthened volatility in global markets can be reflected in exchange rate and inflation expectations.

Medium-term inflation dynamics will be significantly impacted by fiscal policy parameters, in particular, the scale and efficiency of the Government’s measures towards mitigating the consequences of the coronavirus pandemic and overcoming structural constraints, as well as the speed of the 2021-2022 budget consolidation.

If the situation develops in line with the baseline forecast, the Bank of Russia will consider the necessity of further key rate reduction at its upcoming meetings. In its further 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 will hold its next key rate review meeting on 24 July 2020. The press release on the Bank of Russia decision is to be published 13:30 Moscow time.

The reference to the Press Service is mandatory if you intend to use this material.