The Bank of Russia increased the key rate from 12% to 13% per annum

At its meeting on Friday, the Bank of Russia raised the key rate from 12% to 13% per annum. Unlike previous increases, the current one may mean a certain change in the views of Central Bank economists on the process of economic adaptation. The regulator’s adjusted macro forecast suggests that in the coming months, a high key rate will not add much to the observed picture of growth in domestic demand with insufficient supply and simultaneous excess economic activity.

The meeting of the Bank of Russia on the key rate was half extraordinary: in terms of date it was scheduled, but the correction of the macro forecast became unscheduled, which provided the logic of the decision – raise the rate from 12% to 13% per annum. Independent analysts expected an increase, but mostly a “signal” one (within 0.5 percentage points). The August statistical data contained practically no new information on the behavior of inflation; de facto news was only empirically obtained data that the previous increase in the rate did not exert immediate and strong pressure on the ruble exchange rate, and, therefore, the budget for at least the next two quarters will be have more room to reduce the deficit.

The August message from Central Bank Chairman Elvira Nabiullina that the previous increase in the key rate from 8.5% immediately to 12% was not excessive (that is, it exactly corresponded to the ideas that existed at that time about how it would grow over the horizon of five to six quarters) , gave reason to assume that the Bank of Russia did not need a new significant increase in the rate.

Nevertheless, plus 1 percentage point (pp) is no longer a symbolic, but a significant decision at the macro level. Consequently, the Central Bank’s views on what is happening have changed.

Formally, as of September 11 (the date to which the Central Bank refers when reporting on measuring inflation indicators), the macroeconomic situation has already stabilized for a number of indicators. Thus, the Central Bank points to the formed “flat” yield curve for OFZ, stating that it corresponds to “moderately tight” monetary conditions. The monetary policy (MCP) of the Central Bank has almost no direct influence on current inflation; however, there is no radical change in the trend compared to the situation in July-August. Perhaps the only new observation from the Bank of Russia that could influence the decision was the mention of the transfer of the exchange rate to prices. It is difficult to predict the speed of this process; in August, according to the Central Bank, the transfer worked (in previous periods of exchange rate destabilization, it operated with longer time lags than usual). In general, the effect of the pass-through effect in 2022–2023 is apparently the subject of a separate study; in the changed foreign trade conditions, it depends on many factors: from the state and range of imported components in the economy to the situation on the labor market. Now the Bank of Russia considers the changed exchange rate to directly affect current inflation and, apparently, inflation expectations and the nature of consumer demand.

Changes in the Central Bank’s forecast are not radical, but in some cases large-scale. The inflation forecast for 2023 is the main subject of change; on average, its estimates increased by 0.5 percentage points, which is quite consistent with the pass-through effect.

The largest non-technical changes are in the forecast for the dynamics of the M2 money supply (but they are moderate – a change of 1 percentage point, the structure of expected lending has been slightly adjusted) and in the deterioration of the forecast for GDP growth for 2024 from the previous maximum of 2.5% to 1.5 %. Finally, estimates of the balance of payments have been slightly improved: oil prices in the Central Bank’s forecast are higher, as are the expectations for the balance of foreign trade and the current account.

The descriptive model that the Bank of Russia uses to present its view of the situation in which it makes a rate decision has not changed. And in the new forecast, in which the main driver of changes is, in fact, an increase of 0.5 percentage points in final consumption expenditures in 2023, there are no new elements explaining the reasons for such a change. Both preferential mortgages, which worries the Central Bank, and deferred demand for imports, and the pressure of domestic demand through imports on the exchange rate already existed in July in almost the same parameters. The acceleration of inflation in this scheme partly depends on exchange rate dynamics, so a new rate increase is unlikely to surprise anyone – although the Central Bank assumes that its actions will reduce inflation to 4% by the end of 2024, and the average key rate next year will be range 11.5–12.5%.

In the Central Bank’s forecast, everything that is happening looks like a short-term problem.

Nevertheless, so far everything looks paradoxical. On the one hand, the Bank of Russia is raising the key rate in a situation close to overheating, that is, events accompanied by increased business activity in the economy (and, apparently, investment in volumes above normal). On the other hand, even such overheating is not able to provide supply adequate to the volume of domestic demand, and as a result of rising imports, the exchange rate weakens, increasing inflation. It is not obvious what will happen first in such a situation – stabilization of business activity and imports at a point corresponding to a higher inflationary background (the scenario that the Central Bank assumed in the spring and which worried it then), or an increase in supply saturating the stabilizing domestic demand (what the Central Bank called “adaptation of the economy to new conditions of foreign trade” – it is now obvious that this adaptation is not complete and, at best, has passed only the first stage, which will be followed by others). For now, the Central Bank is betting that a weakening exchange rate will reduce demand for imports. “In the coming quarters, demand for imports will adjust to the weakening of the ruble and decisions made on the key rate,” the regulator notes. The question is what will happen in such a situation with unsatisfied domestic demand – one of the possibilities is its further reorientation towards the domestic market and, accordingly, a new inflationary impulse.

In any case, the Bank of Russia has made it clear that it will maintain the period of high rates for quite a long time, if only because the market’s expectations of a rapid reduction in the key rate creates problems for the operation of the monetary policy transmission mechanism.

The Central Bank is already noting the flow of funds from households and companies from current accounts to time deposits and a number of other events corresponding to the increase in the population’s propensity to save.

One of the additional problems noted by Bank of Russia analysts is the coincidence of trends towards increasing private and public consumption – they are growing synchronously. “The confident growth of domestic demand is due to the expansion of private demand while maintaining government demand at a high level,” indicates the board of directors of the Central Bank. In this situation, limiting the growth of government consumption would contribute to the goals of the Central Bank, but these levers are not in the hands of the monetary regulator.

Dmitry Butrin