The Central Bank raised the key rate to 16%

The new increase in the key rate by the Board of Directors of the Bank of Russia was predictable. Inflationary pressure indicators continued to grow in November-December 2023, growth above potential continues, and even a new rate of 16% per annum may not be sufficient to reduce it to a balanced level. Inflation at the end of the year began to be fueled by the services market, GDP growth for the year will certainly exceed 3%, unemployment will obviously remain below 3% with employment growing. The Central Bank is now raising the rate largely forcedly – any inconsistency in monetary policy will destroy the regulator’s strategy, and long-term growth above potential threatens medium-term economic prospects.

One can argue whether the level of the Bank of Russia key rate above 15% is a protective level or not, but it is now higher – the Board of Directors of the Central Bank at its meeting decided on its new value of 16% per annum. According to the Chairman of the Bank of Russia, Elvira Nabiullina, two decisions were actually discussed – keeping the rate at 15% or increasing it by 100 basis points (bp), proposals to increase the rate by 200 bp. There were some, but they didn’t vote. Probably, the date of the next scheduled council meeting, February 16, largely contributed to the decision to increase the rate – fluctuations in demand, which remains significantly higher, at the “transition of the year” in January can be significant for inflation and inflation expectations, namely with increased inflation Bank of Russia is consistently struggling, increasing the rate from August, when it was 7.5% per annum, to the current level of 16%.

Although in itself, with double-digit core inflation figures (the Central Bank was guided by the indicator of the basic consumer price index BICP in October-November, 11.5% year on year with seasonality removed, for the BICP this is a very large value), such an increase is not very significant and separately then it is not important for the markets; the current increase is significant in another aspect. The Central Bank does not change the parameters of the economic forecast, including annual inflation ending in 2023 – its ceiling in Bank of Russia estimates is 7.5%, the Central Bank admits that it may go beyond these limits. GDP in 2023 will grow, and the Central Bank admits this, by more than 3%, significantly higher than the potential, which is a maximum of 1.5%.

The engine of inflation is still the excess of demand over supply; the effect of transfer of the exchange rate into prices, according to the Central Bank, is practically exhausted. The signal from the Bank of Russia in the press release is absolutely neutral. Nevertheless, it was so in both October and December 2023, so in February 2024 it is no longer possible to exclude a further increase in the key rate (for example, in smaller increments of 25–50 bp) – the scale of overheating of the Russian economy is still increasing , the effect of the Central Bank’s actions in August-October remains only signs of cooling of markets, but not cooling as such. Moreover, part of the questions at the press conference of the head of the Central Bank was devoted to the already known “microeffect” on the part of households – information about a new increased rate level can short-term warm up inflation expectations and lead to a rapid increase in their spending: in this logic, it is better to buy now than later , when prices increase, it doesn’t matter whether it’s a preferential mortgage (the hit of the season in savings), a car or a ballpoint pen. And the New Year is the best time to apply this logic: the words of the head of the Central Bank that the best gift for the New Year is for yourself, and this is a deposit, only caused smiles from the event participants.

In fact, the Central Bank could hardly refuse to raise the rate – otherwise it would almost inevitably have to adjust the forecast for inflation at the end of 2024, when it should be 4–4.5%, that is, within a year, return to the Bank of Russia’s target and beyond remain at the level of 4% per annum.

After a long series of rate hikes with a consistent increase in inflationary pressure, markets are almost guaranteed to take this as capitulation by the Central Bank. “Confidence” in its monetary policy, which the regulator seeks, is not the best term here, since it means in this context that markets must be confident that the Bank of Russia will achieve its goal by increasing the rate until it is confident that that the goal will be achieved in any case and in the near future inflation should go into a steady decline. In fact, the Central Bank’s decision to increase the rate only increased the expected “steepness” of the inflation decline curve in 2024 – the alternative was, apparently, only the time of maintaining it at its peak, which will also occur in 2024, but at the beginning, and not at the end.

The Bank of Russia is already confidently placing emphasis in its comments on the current economic situation on the state of the labor market – this is the main limitation for future growth, unemployment is about 2.9%, and in parallel, employment is also growing (the share of workers in the total population), and the head of the Central Bank complemented this observation by others – both the volume of hours actually worked and the number of shifts at enterprises are probably growing; the demand for labor is so great that it probably won’t be possible without an expected increase in hours in actually worked weeks.

Let us note that restricting Russia’s access to new, less labor-intensive technologies should, in principle, lead to a more extensive use of labor—in other words, the growth in output is partly ensured by an increase in labor that is less productive than before, and this effect may further expand slightly.

Another obvious sign of problems in the labor market is the resumption of strong inflationary pressure in services, which the Central Bank notes.

It is in the cost of services that the share of the wage fund is high; wages will rise here too due to a shortage of personnel. In this configuration, the problem of personnel shortage will be solved in the short term only by the new Stakhanov movement. Demand for services is also growing faster than supply – labor is needed to satisfy it, they are in short supply and cost significantly more than before, this is reflected in the prices of services.

The functioning of the economy in conditions of growth above GDP potential (“overheating”) is a subject of medium-term concern for the Central Bank, the head of the Bank of Russia confirmed on Friday. Thus, one of the side consequences of such growth is considered to be non-optimal investments (recall that the level of investments in the Russian economy in 2022–2023 is significantly higher than the norm) – in fact, investment errors that in the future will not be able to bring investors the expected return on investment, but in the limit – will lead to losses and write-offs. Investing in a situation of “overheating” reduces the potential for medium-term GDP growth (although the Central Bank did not make quantitative estimates in this regard), and this is only part of the unplanned consequences of unplanned growth, which by the end of 2023 pleases regulatory authorities with outstanding figures.

The rigidity and consistency of the Central Bank, we note, does not eliminate the possibility of stopping growth due to external pro-inflationary risks – new sanctions, a global economic downturn, continued devaluation, and the unobvious consequences of the rapid fragmentation of world trade. However, the Bank of Russia also sees disinflationary risks, although their realization is less likely than the realization of pro-inflationary risks. In fact, the already implemented increase in the key rate is very significant. And although the Central Bank still states that the period of keeping the key rate at a “high” (without specification) level should be high (presumably the entire 2024), the real speed of implementation of the consequences of these decisions cannot be calculated with an accuracy of even a quarter: it will not be surprising very fast real cooling of markets in the first half of 2024. But to do this, you must first wait for the peak of “overheating” – it continues, the Russian economy enters the new year in exactly this state, and you will have to pay for the euphoria in the next year.

Department of Economics