Russia: High inflation forces CBR to hike key rate, but response likely to be cautious
Metodi Tzanov
Helping finance professionals understand what is going on in Emerging and Frontier Markets
We think the CBR will be forced to hike the key policy rate this week in response to much higher-than-expected current inflation, but we expect a decision that is more dovish than the consensus. Thus, we see chances for a 200bp rate hike in combination with more dovish rhetoric suggesting that this is the end of the tightening cycle or a below-consensus 100bp rate hike. The majority of local analysts expect a 200bp rate hike with a significant minority betting on a more radical hike of 3-4pps.
By far the main argument for a rate hike is current inflation, which climbed to 9.3% y/y as of Dec 9 compared to the CBR forecast that it will be slowing down toward 8.0-8.5% y/y at the end of 2024. This alone should normally be enough for a significant rate hike. The latest surge in inflation from 8.9% y/y in November reflects the ruble weakening at the end of November, which contributed around 0.4-0.5pps to the acceleration of headline inflation, but inflation was running above the forecast also before that, driven mainly by food prices. Inflation expectations also remained high at 13.4% in November and will likely increase further this month.
Arguments against further tightening have also strengthened and they are mainly related to monetary and credit conditions. The marked deceleration in household lending continues, while corporate lending also started to slow down in November. Besides, the CBR has taken regulatory measures to tighten corporate lending with macroprudential limits from April 1, 2025, while the FinMin announced steps to reduce interest rate subsidies for lending to companies. These subsidies are often blamed for reducing the effectiveness of key rate hikes in fighting inflation and it can be argued that their reduction is effectively tightening of monetary policy. Another dovish argument is the continuing tightening in monetary conditions as banks hiked both deposit and lending rates in November. There was further increase in December, partly fueled by expectations of a forthcoming policy rate hike.
Developments in the real economy are more mixed. We noted an observation by the CBR in its December economic report that the contribution of demand to inflation has declined for the first time since March. The debate as to whether high inflation is driven predominantly by supply or demand factors has been a key one and the CBR previously defended the view that demand was the main culprit. Otherwise, signs of economic slowdown are still weak with retail sales growth high at 4.8% y/y in October and unemployment declining to a new record low of 2.3%. PMI indices actually improved in October and November.
The exchange rate has mixed implications as the ruble rebounded in December after the sharp drop and weekly inflation is likely to slow down in the remaining weeks of the month. The higher base from December will also help the inflation forecast for 2025.
Apart from macroeconomic considerations, we believe there is growing pressure on the CBR to halt monetary tightening. This was seen in statements of government officials and especially managers of state companies and banks. Most noteworthy were comments by President Putin, calling on the FinMin and the CBR to work together and also pointing at supply-side decisions as the key to reducing inflation. This seems more in line with the view of the EconMin that inflation is driven by supply-side factors and further CBR rate hikes have little effect on it, while suppressing the economy.
With all this in mind we will not be surprised to see the CBR move gradually from "if inflation is not falling fast enough it means the key rate is not high enough" toward "the key rate is at an adequate level, but it will take more time for the effect to be felt". If this is the case, we can expect a smaller rate hike or the consensus hike of 200bps with a comment that the key rate is likely to stay at that level for longer.