The Central Bank of Russia shocked the market hard review

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Central Bank surprised the market hard review, the Central Bank did not change the rate, keeping it at the level of 7.25%, but plans to postpone the normalization of monetary policy. The Central Bank has not changed the key rate, keeping it at the level of 7.25%, in line with our expectations.
Nevertheless, the review this time was more rigid in comparison with what you would expect. The Central Bank raised the inflation forecast to 3.5-4.0 per cent for 2018 (originally the Central Bank’s forecast was for 3.0-4.0%) and to 4.0-4.5% 2019 (initially about 4.0%). The Central Bank also noted that the transition to a neutral monetary policy is deferred for the longer term due to changes in fiscal policy and recent increases in inflation expectations.
The focus of the regulator the risk of inflation. Recent months are characterized by the appearance of a number of negative news, which is probably determined more cautious approach Central Bank rate decision.
First, although inflation remained at 2.4% yoy for the last three months (March to may), the growth of prices for non-food goods accelerated sharply in may from 2.7% y/y to 3.5% y/y, responding to the surge in gasoline prices and the instability of the ruble. Only thanks to the continued decline in food prices (food price rises slowed from 1.1% yoy in April to 0.4% yoy in may), annual inflation has not accelerated.
Second, the acceleration of nonfood inflation have impacted consumer sentiment – expectations of inflation jumped to 8.6% in may, to its highest level since the beginning of this year. Finally, the recent government decision to raise VAT from 18% to 20% will lead to an acceleration of inflation (increase of prices amount to 1 percentage point, according to the Central Bank, and 0.8-1.0 percentage points, according to our estimates). All three factors served as strong arguments in favour of the Central Bank embarked on a tightening of its rhetoric.
Geopolitical issues are hidden fears. Although geopolitical risks in the commentary they say indirectly, we believe that they clearly raise very serious concerns of the Central Bank. The regulator had been overly optimistic in 1К18; April sanctions come as a negative surprise and we believe they will remain an important challenge for the Central Bank in the near future. Because of this, now of the Central Bank excessively reacts negatively to changes in fiscal policy: the decision to raise VAT in principle is not so much a surprise as it was discussed for a very long time, and in 2017, the government even considered the scenario of increasing VAT to 22%.
Thus, the current increase in VAT to 20% is a rather neutral event. On the other hand, we fully support the Central Bank rate on the more cautious rhetoric in our opinion, in the current situation is the most correct approach. Due to concerns related to the sanctions we had previously expected the rate cut cycle will reach the bottom at the level of 7.5% and the Central Bank’s decision to stay at the level of 7.25% at the moment in line with our understanding of the scale of geopolitical risks.
The scenario of a pause in lowering rates – most likely in the coming months. A new, much more cautious rhetoric review, the Central Bank takes away the obligation to decrease rates to the neutral level of 6.0-7.0% this year, and significantly increases the room for maneuver in the future. This assumes that the script pauses should be considered as a base for the coming months.
Of course, absolutely rule out another rate cut this year should not, however, this step is possible only in case of improvement in Russian-American relations, stabilization in emerging markets and in the case of softening of rhetoric of the fed – but this combination of factors now looks overly optimistic scenario. Thus, we expect that at the next meeting on 27 July, the regulator will leave interest rates unchanged and, most likely, it will be at the level of 7.25% to the end of the year.
Центробанк России шокировал рынок жестким комментарием
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Natalia Orlova,
The head of the Center for macroeconomic analysis
Alfa-Bank