Bank Rossii set to hike on high inflation

Russia’s central bank Bank Rossii will announce its decision regarding key rates on 31 October at 11:30 CET. We expect a 100bp hike in the key rate as data available as of 22 October indicates that inflation has reached 8.3% y/y – far from the central bank’s target of 5% y/y for 2014. As of 22 October, consensus expects a 50bp rate hike.

The geopolitical environment and the oil price (down more than 25% from its 2014 highs) are weighing on the Russian economy and on consumer prices through sanctions and a weakening rouble. Uncertainty regarding new sanctions is pushing up inflation expectations. Bank Rossii’s most recent statement on a key rate decision from 12 September already sounded slightly hawkish, reiterating that ‘if inflation expectations remain at the elevated level and the threat of inflation exceeding the target in the medium term emerges, the Bank of Russia may continue raising the key rate.’ On 22 October, Bank Rossii’s first deputy governor Sergei Shvetsov said that target inflation remains at 4% y/y and the central bank ‘has the instruments to reach it’. As Bank Rossii is going to let the RUB into free float in 2015, intervening less, the only reasonable instrument available to the bank to control inflation is regulation of the key rate. At the same time, Shvetsov stated that the central bank ‘will have to look seriously at increase of interest rates if current direction continues.’ 

Rate hikes set to weigh further on the Russian economy

We have been constantly reiterating that Bank Rossii’s tightening monetary policy is not biting accelerating CPI in Russia as inflation in the country is of non-monetary nature. In early October 2014 in Moscow at VTB’s Capital Investment Forum we heard Bank Rossii’s governor Elvira Nabiullina saying that the bank understands the problem but that there is a share of CPI which can be affected by changes in monetary policy. Yet, we see that continuously tightening monetary policy in Russia is having a more devastating impact on the Russian economy than accelerating inflation, falling oil price or sanctions environment. Fixed investments continue to shrink, posting -2.8% y/y in September 2014 and -2.5% y/y in January-September 2014. Demand-side shock caused by a total of 250bp key rate increases within five month in 2014 has already started to depress private consumption to some extent as retail sales growth slowed to 1.7% y/y in September 2014 from 4.1% y/y in March 2014. New car sales shrank 20% y/y in September from 0% y/y in March. Loans to households growth has also decreased. As the effect of tightening monetary policy on fixed investments and private consumers will be seen with a lag, we expect private consumption to shrink in 2015, despite the growth in 2014. Since April 2014, we have expected that together with shrinking fixed investments this will seize Russia’s GDP by 1.8% y/y in 2015. However, more monetary tightening and a falling oil price would bring downside risks for our negative forecast.

We do not expect any significant impact on RUB’s spot rate from tightening monetary policy in the medium or long run as the RUB FX rate has recently been driven by other factors as oil price, expectations of FX shortage on financial sanctions or weakening macro. As we have seen before, some strengthening on rate hikes would last for several days only. As we stay bearish on the RUB in the long run, we recommend keeping a high hedging rate, especially for USDRUB in 6M and 12M.