The Central Bank kept the rate in hopes of cooling demand

Following the results of the March meeting, the Bank of Russia kept the key rate at 16% per annum. The regulator is discussing how sustainable the slowdown in inflation is, but expects a rate cut only in the second half of the year. The Central Bank notes the continued tightening of labor market conditions against the backdrop of increasing domestic demand. The growth of savings does not prevent high consumption from continuing. In a normal situation, when the monetary policy is tightened, it should fall, but so far this has not happened.

Following the results of the March meeting, the Board of Directors of the Bank of Russia kept the rate at 16%, noting in a statement that inflation pressure is gradually weakening, but remains high, and in the economy not only the excess of demand over supply remains, but also the rigidity of the labor market has increased again. This is the essence of what is happening, which explains the decision: the means to combat economic overheating are working, additional measures are not necessary, but it is too early to reduce the rate in parallel with the fall in inflation.

The head of the Central Bank, Elvira Nabiullina, and her deputy, Alexey Zabotkin, stated on Friday, March 22, at a press conference following a meeting of the regulator’s board of directors: the peak of current inflation has passed in the fall of 2023, the annual peak (the last 12 months) will apparently be passed in the second quarter 2024. Thus, there is no reason to consider rate increases in 2023 to be ineffective; disinflation is ongoing, just at a moderate pace for now. According to the Central Bank, it is still premature to judge the further speed of disinflationary trends. This is evidenced by the wording about the need for long-term maintenance of the strict conditions of the monetary policy. A more sustained decline in inflation and inflation expectations, as well as an easing of labor market pressures, will be required for the rate cut, which is currently expected to take place in the second half of the year, to begin.

The current one differs from previous tightening cycles in that strong savings growth is accompanied by strong consumption, despite tightening credit conditions. This is an unusual situation, noted Elvira Nabiullina.

Lending activity is slowing down, but rather unevenly: corporate lending has been growing at a restrained pace since the beginning of the year (this is also due to advances on government contracts), mortgage issuances have become slightly lower than last year, and the growth rate of the retail loan portfolio has decreased, but is still high . The dynamics of deposits, according to the Central Bank, is significantly ahead of the seasonal norm, which is largely due to income growth. This effect will intensify if tight policies continue to be maintained—an increase in the savings rate should cool consumption.

High demand is still preventing a sustainable slowdown in inflation: in December-January the regulator observed a significant slowdown in the current price growth; in February it stopped, but in March, according to preliminary data, it resumed. This assessment, however, is carried out based on a truncated sample, so it is too early to judge the rate of decline in price growth in March, Ms. Nabiullina explained. Most of the stable (less volatile) indicators of current price growth, according to the regulator, are in the range of 6–7% in annualized terms – in the fall, these indicators were double-digit (which is reflected in higher annual inflation rates: as of March 18, it amounted to 7 .7%). In February, foreign tourism became more expensive, so core inflation at the end of the month increased from 6.8% to 7.7% (without this component, the price increase would have remained comparable). The Central Bank also notes an acceleration in growth in other services while a slowdown in product categories. This also indirectly indicates higher consumer demand. Although inflation expectations are declining, they remain high, which in itself is a factor stimulating current consumption.

As for the output gap—the deviation of the GDP growth rate from the equilibrium one, which, within the framework of the Central Bank’s concept, causes an increase in inflation—it, according to the Bank of Russia’s assessment, persists and remains large, but whether there are significant changes in the parameters of this gap is unknown.

Growth in economic activity has also picked up again after slowing late last year. First of all, this concerns household consumption (demand sentiment is at its maximum, and interest in large purchases has been growing since December), but also the investment activity of companies: the production of investment goods has reached historically high volumes, investment imports are also growing, the business climate indicator has reached its maximum in 12 years old, said Elvira Nabiullina. The economy, in any case, is in the investment phase of growth, which is explained by its structural transformation: both production capacity and labor resources are almost fully utilized, and growth is above the potential level and results in the persistence of increased inflationary pressure, she explained.

The main pro-inflationary risk remains a worsening labor shortage: unemployment fell to 2.7% seasonally adjusted in January, a record low. A better correspondence to the idea of ​​“full employment” cannot be imagined. The greatest increase in employee shortages is observed in metallurgy, pharmaceuticals, chemical industry and mining. Increasing competition for employees means that productivity growth will increasingly lag behind the pace of wage increases. This, in turn, can lead to a widening imbalance between the dynamics of supply and demand in conditions of high capacity utilization. In principle, this (in addition to the actions of the Central Bank) is a probable scenario for stopping overheating. However, Alexey Zabotkin stated that until this scenario is realized, there is no turnaround in the labor market.

Satisfying increased demand with imports (it is below the peak values ​​of 2023: according to the Federal Customs Service, import volumes at the beginning of this year are 6–7% lower than last year’s values) is also becoming more difficult: to increase it, it is necessary to increase exports, and the possibilities for increasing it are limited. In general, the Central Bank assesses the situation with supplies abroad optimistically – prices on commodity markets are rising, although the impact on Russian supplies is limited by the strengthening and expected risks of secondary sanctions. The dynamics of imports, against the backdrop of strong domestic demand, still remains elevated. It should also be balanced by a stricter monetary policy; imports will then correspond to the “opportunities” of exports.

Tatiana Edovina, economics department