Hawk rate: the Bank of Russia surprised with its rigidity at the key rate

The main thing that this time wanted to understand from the answers of the head of the Bank of Russia Elvira Nabiullina at a press conference after the meeting of the Board of Directors of the Central Bank of the Russian Federation, both observers and members of the press are the reasons for such a strong (immediately by 1%) increase in the key rate. Inflation, which the regulator usually refers to, is about 3.15% in July, which is more than a modest figure. The economy is gradually growing and returning to pre-crisis levels. Why, against this background, did the Central Bank of the Russian Federation decide to tighten its policy so drastically and what consequences will this lead to on the financial market?

The last time the market saw the key rate at 8.5% was in December 2021, and this figure was also raised immediately by a percentage then. That period in the economy passed under the auspices of the post-pandemic recovery.

Recall that Russia’s GDP, according to estimates by the Ministry of Economic Development, grew by 4.6% in 2021 after a subsidence of 2.7% in 2020. One can argue that there were no sanctions, no geopolitical tensions, no shortage of personnel in the labor market at that time. However, inflation, the targeting of which is the goal of the Central Bank of the Russian Federation, at that moment was almost 2.5 times higher than the current figure: it amounted to 8.4% in 2021, according to Rosstat.

In December 2021, the head of the Bank of Russia, during the press conference, which became the penultimate one, to which she put on a brooch hinting at the state of the market (then it was a symbol of the New Year’s fairy tale – the Nutcracker), spoke about the importance of achieving the inflation target of 4%.

But this year, annual inflation in June was 3.25%, the regulator improved the forecast for GDP growth in 2023 to 1.5-2.5%. According to Nabiullina herself, the economy of our country has reached its pre-crisis level, with the exception of the oil and gas sector, which is under sanctions pressure. However, the key rate was still raised by 1% at once, and Russia, in a financial sense, seemed to be back again in December 2021.

Experts, commenting on today’s decision of the Central Bank of the Russian Federation, suggested that the regulator decided to take into account the future impact on prices and the economy as a whole of the greatly depreciated ruble. For six months, it lost a third of its value against the dollar, and compared to July 2022, it lost 70%. Even after the start of the NWO, the decline of the domestic currency against the dollar was not so strong in annual terms.

In part, the regulator confirmed these assumptions with their cautious statements. “Movement of the exchange rate lately has not yet been completely transferred to prices,” the head of the Central Bank said during a press conference. At the same time, she explained that the weakening of the ruble is, although a significant factor for rising prices, but at the moment it is not the main one in this process. “In our opinion, the key factor for us now is the excess of demand over the possibilities of expanding supply,” Nabiullina said. “And this is due to supply-side constraints, including a lack of labor.”

The reason for the dramatic depreciation of the ruble against the dollar in June, according to the Bank of Russia, should be sought in the dynamics of foreign trade. “The increase in demand affected the rapid recovery of imports, which, along with the decline in exports, contributed to the weakening of the ruble,” the head of the Central Bank said.

She already expressed this idea at the Financial Congress in early July, urging the market not to build “conspiracy theories”. The regulator monitors the situation with the trade balance and is also concerned about the possible strengthening of restrictions on Russia at the international level. The Central Bank, judging by the statements of its chairman, predicts not the best scenario. “The deterioration of external conditions, including the possible tightening of the sanctions regime, remains a significant risk,” Nabiullina said.

Another sign indicating that the regulator believes that the situation may worsen in the future was a direct statement of readiness to further tighten monetary policy. “We gave a signal that we admit the possibility of raising the key rate at the next meetings,” the head of the Central Bank said, noting that the average level of this indicator at the end of the year would be in the range of 8.5-9.3%.

With regard to currency restrictions, the Bank of Russia advocates maintaining only response measures to Western sanctions, and considers it possible to remove the rest in order to “give more opportunities and freedom to businesses to build new logistics routes, relationships with counterparties.”

Elvira Nabiullina gave some interesting statistics regarding the yuan when answering the question “MK in Chita”. As it turned out, Russians are extremely reluctant to keep funds in Chinese currency. “Indeed, we are now seeing the emergence of some interest of our citizens in order to keep funds in bank accounts in yuan, but so far this practice is not very common, while deposits in yuan make up somewhere around 1% of the total amount of funds of individuals in banks,” said the head of the Bank of Russia. However, she refused to recommend to Russians the currencies in which it is best to keep deposits, pointing out that the Central Bank of the Russian Federation “does not interfere in the market practices of banks” if they do not bear risks for the system and consumers.

The head of the regulator once again reminded that any deposit in foreign currency carries a risk. Due to the constantly existing stock exchange difference between the buying and selling rate, any foreign currency deposit is more like an investment, where “it is impossible to predict exchange rate fluctuations and exchange rate risks,” Nabiullina warned.