Russia’s central bank: dispersing the doves

Assessment and outlook

On Friday 28 October, Russia’s central bank kept its key rate unchanged at 10.0%, in line with the unanimous consensus. While the general tone of the CBR’s statement was broadly expected, the central bank added a pinch of hawkishness to its potential downgrades due in Q1-Q2 17, which it had already declared in September. The hawkishness derives from enhancing unsteady disinflation and a slowing deceleration of inflation expectations, which lead us to expect the next cut in Q2 17. The market pricing has also moved towards a cut in Q2 17, from early Q1 17 previously.

The following are the main reasons behind today’s decision.

1. ‘Inflation continues its decline in line with the CBR’s baseline forecast; however, this is largely due to temporary factors’. According to the CBR, inflation fell to 6.2% y/y as of 24 October, while at the time of the previous rate decision (a 50bp cut) in midSeptember the CPI was 6.6% y/y. Yet, the CPI decreased further due to temporary factors such as the good harvest. The CBR expects inflation to be around 4.5% y/y in October 2017 (previously in September 2017), reaching its 4% target by late 2017. We believe that if the CBR delays the next rate cut until Q2 17, it will create downside risks for our 2017 GDP growth forecast of 1.2% y/y.

2. ‘Positive real interest rates will be held’ to secure demand for credit, while excluding inflationary pressure and keeping incentives to save. With the prolonged tight monetary policy, the CBR shows it is not willing to boost demand for credit, which we also see being macro negative as real rate is set to exceed 3%. Previous public statements by Governor Elvira Nabiullina declared that the CBR is even ready to stay above its upper level of real interest rate corridor (3%) for a period of time. However, if the current external conditions prevail in 2017 and crude’s average price climbs over USD55/bl in 2017, we expect the key rate to fall 300bp by the end of 2017.

3. ‘The CBR estimates that moderately tight monetary conditions do not hinder economic recovery’. The CBR reiterates that in 2017, GDP growth will not be high, staying below 1%’, while our 2017 GDP forecast remains 1.2% y/y. We interpret the CBR’s conservative forecast as a willingness to achieve its 4% CPI target at any price by the end of 2017 

4. ‘Risks remain that the 4% inflation target may not be reached in 2017’. The CBR reiterated its concerns about possible global volatility risks and uncertain fiscal consolidation in 2017, as the three-year budget has not yet been approved.

5. Inflation expectations of market participants for late 2017 hold above the CBR’s inflation target, which may hinder disinflation. This is a new reason and dimension, which we believe is dispersing the remaining doves from the market.

The RUB got some support from the decision, as the statement’s hawkishness erased hopes of a rate cut early in Q1 17. Yet, the USD/RUB could not hold long under the resistance level of 62.86 as the falling oil price added to the currency’s swings. We remain slightly bullish on the RUB, as carry traders like the currency in order to benefit from the large interest rate differential. We have kept our USD/RUB forecasts at 62.00 (3M), 59.50 (6M) and 57.10 (12M) seeing the Fed’s possible rate hike in December 2016 as the major upside risk for our USD/RUB projection.

Russia’s local bonds – OFZs – did not like the CBR’s attack on doves. Yet, while we recommend staying on hold, we see such dips in OFZs as a buying opportunity, as, in our view, the CPI is set to decrease in 2017.

There are certainly external risks present, which could keep the RUB weaker and inflation elevated: the Fed’s monetary stance could become more hawkish than expected in 2017, sending crude and emerging market sentiment down. New western sanctions could also weigh on Russia’s assets. While we believe these risks are moderate in the medium term, the CBR prefers to stay conservative and overcautious. We expect the CBR to keep rates unchanged at its monetary policy meeting on 16 December 2016.