Bringing intrigue back into Russian monetary policy is a tall order.
In a region littered with broken promises by central banks, Russia’s Governor Elvira Nabiullina just made an unprecedented pledge to leave interest rates unchanged the rest of the year. Should Russian inflation continue to surprise after decelerating to a 31-month low of 6.4% in September – slowing more than estimated by economists and at the lower end of the central bank’s forecast – ING Group NV and B&N Bank PJSC say policy makers could still raise the possibility of walking back their commitment.
“If it falls below 5.5%, I think the central bank will ‘break’ its word,” Nataliya Shilova, chief analyst at B&N Bank PJSC in Moscow, said by e-mail. “After all, the central bank is targeting inflation, not rates, so it can opt for easing in 2016” if it concludes that a goal of 4% for 2017 will “definitely be reached and maintained.”
The path of inflation in the coming months can determine the central bank’s ability to resume easing after its “moderately tight” stance allowed for only two reductions this year. Policy makers are targeting price growth of 4% by end-2017 and see it reaching 5.5% to 6% in 2016 after overshooting their forecasts for a fourth consecutive year in 2015.
“Inflation needs to reach a level near 5% or lower to add intrigue to the issue of a rate decrease before year- end,” said Dmitry Polevoy, chief economist for Russia at ING. Still, “I don’t think the central bank will go for it because they are risking nothing. If everything turns out better than they expected, they’ll simply have an easier time cutting at the start of 2017.”
Revisiting policy pledges wouldn’t be without precedent in eastern Europe or the former Soviet Union. Five months after saying rates may remain on hold into 2019, the National Bank of Hungary in March restarted an easing cycle with a cut to a record. In Kazakhstan, less than a week after the governor said borrowing costs will fall once inflation drops within a target band, the central bank lowered its benchmark even though price growth remained more than double the upper end of the range.
Derivatives traders are already adjusting their bets for a Russian rate cut in the next three months. Forward-rate agreements now indicate 23 basis points of easing, up from last month’s low of eight basis points. Three of 24 economists polled by Bloomberg predict the 10% benchmark rate will be cut already this year. It will decline to 8% by the end of 2017, according to the median of forecasts.
The rouble, which has contributed to a letup in prices, has been trading near the strongest in a year, reaching levels that prompted President Vladimir Putin in July to warn his prime minister that its appreciation relative to oil needed to be watched.
The Russian currency added 0.3% against the dollar yesterday in Moscow.
After a cut in September that the central bank said was probably this year’s last, Nabiullina called another decrease “an extremely remote possibility” but allowed for some wiggle room.
“I do admit there is a slim chance this might happen – but only if we see a substantial improvement against our baseline scenario,” she said.
While the central bank may restart easing in the first half of next year, positive real rates will remain in place for “quite a long period” in order to anchor inflation expectations at 4%, according to Nabiullina.
Expectations for the next 12 months, a key determinant of monetary policy, rose to 14.2% in September after slowing to 12.6% the previous month, according to results of a survey published by the central bank. Increases in non-food prices and the cost of services are another area of concern.
Their “resilience” in August “requires attention, implicitly justifying the cautious stance” of the central bank, according to ING’s Polevoy. Still, Goldman Sachs Group economists predict the annual consumer-price index will be at 5.3% in 2016 and reach 3.6% at end-2017.
VTB Capital revised its 2016 inflation forecast to 5.8% from 6.1% after September’s data and said the exchange rate “remains key” to prices because a significant share of the consumer basket consists of items sensitive to currency moves.
However, Russia’s seasonally adjusted monthly inflation is still probably higher than the central bank’s target range, it said in a report.
“The print adds to the string of positive disinflation surprises,” VTB Capital analysts led by Alexander Isakov said in the report. “From the monetary policy perspective, we view this print as an element in the case for restarting cuts in the first quarter of 2017.”
While “sizeable” rate cuts loom in 2017 and 2018, the bigger-than-forecast drop in inflation last month won’t have “much impact” on policy this year, according to Capital Economics.
“It would take a much larger inflation surprise to bring rate cuts back onto the table before the year is out,” said Liza Ermolenko, a London-based analyst at Capital Economics.