Russia's central bank: on hold, unleashing hawks

Assessment and outlook

The CBR kept its key rate unchanged at 10.0% on Friday 3 February, in line with our expectations and consensus. Yet, the general tone of the CBR’s statement has turned more hawkish, as Minfin is starting its FX operation mechanism, economic prints look better than expected while external political and economic uncertainty remains high. The central bank stated that its capability to cut its key rate in H1 17 has diminished. Thus, we still expect the CBR to start cutting rates in Q2 17, while seeing the key rate higher than before by the end-2017 (8.0% versus 7.0% previously).

The main reasons behind today’s decision and the CBR’s tone

• ‘Inflation continues to decline in line with the Bank of Russia’s forecast. This is due partly to temporary factors’. The assumption stayed unchanged since the last decision in December 2016. According to the CBR, inflation had fallen to 5.1% y/y as of 30 January, while at the time of the previous rate decision (unchanged) in late December, CPI was at 5.6% y/y. Given the current trend and our Brent crude price forecast at USD59/bl for the end of 2017, our models show that the CBR’s inflation target of 4% y/y by the end of 2017 is reachable, despite elevated risks of weaker disinflation on FX purchases by the Minfin.
• ‘Positive real interest rates will be held’ to secure demand for credit, while excluding inflationary pressure and saving incentives for when needed. The assumption stayed unchanged since the last decision in December 2016, although the CBR referred to the FX operations mechanism’s impact on money markets rates as being ‘almost immaterial’. We attribute the ‘almost’ expression as being slightly negative though.
• ‘Economic recovery in 2016 was somewhat above the Bank of Russia’s expectations’. Here, we see the turn towards more hawkishness in this assumption as the CBR would experience less pressure to cut on economic factors. The latest GDP data showed that in 2016 the economy surprisingly shrank much less than expected: - 0.2% y/y versus -0.5% y/y by consensus), while the 2015 GDP contraction was revised up for the third time to -2.8% y/y from -3.0% y/y (the first print was -3.7%).
• ‘Risks remain that inflation will be above the target level of 4% in 2017’. The CBR stated that ‘external political and economic uncertainty remains elevated, which may affect expectations negatively as regards the exchange rate and inflation’. While the crude price has stabilised at high levels, we see the risks mentioned above to be the following:
  • More-than-expected rate hikes by the Fed on President Donald Trump’s potentially expansive fiscal policy.
  • A slowdown in China’s economy towards end-2017.

As the CBR and the Ministry of Finance have interacted closely and successfully, we expect the trend to continue to reach 4% y/y by the end of 2017. We expect the CBR to keep rates unchanged at its monetary policy meeting on 24 March.

Minfin is starting the FX operations mechanism

Today on 3 February, before the CBR’s decision, Minfin made its first announcement about the new FX operation mechanism: as oil and gas revenues are estimated to deviate from the budget assumption by + RUB113.1bn in February 2017, Minfin will be buying daily FX with RUB6.3bn (approximately USD106m/day). This is a much larger amount than Minfin estimated last week, when the mechanism was introduced. The current monthly amount (from 7 February to 6 March) is approximately USD2bn versus USD1bn promised earlier.

The RUB took the comeback of hawkishness positively

The RUB strengthened after the CBR’s statement was released, enjoying the hawkish tone as the carry trade opportunity is set to go on further into 2017 on high real rates and an increasing crude price. Minfin’s earlier decision to start buying daily FX with RUB6.3bn didn’t stop the RUB from appreciating although it put a brake on the rally somewhat. We keep our moderately bullish stance on the RUB based on our latest FX forecast update released in mid-January. We still expect the USD/RUB to hit 58.70 in 1M, 56.10 in 3M, 55.10 in 6M and 51.15 in 12M on a Brent crude price assumption of USD59/bl in Q4 17. Yet, we see upside risks for our short-term USD/RUB forecasts on the market’s reaction to FX purchases, which start on 7 February. Russia’s local bonds – OFZs – cooled down on the CBR’s hawkishness. Yet, we remain bullish on OFZs, recommending buying before Q2 17.