The Central Bank of Russia (CBR) surprised analysts with a 50bp rate cut to 7.75% on December 15 at its last meeting of the year. Inflation is at a record low of 2.5%, but given the regulator believes the current inflation level is temporary, analysts were almost universally expecting a 25bp cut.
“The CBR decision to cut the key policy rate by 50bp came as a complete surprise to the market, reflecting weakness in communication,” Natalia Orlova, chief economist at Alfa Bank, said in a note.
In polls, 14 analysts out of 15, according to the Reuters consensus, and all 33 participants in a Bloomberg poll, expected a 25bp rate cut.
“This confirms our take that the previous CBR comment from 27 October was far from clear to the market and that communication from the monetary authorities is losing clarity,” Orlova complained.
This is the sixth time the CBR has cut rates this year, while inflation has been falling fast, driven down in part by an all-time record harvest of 133mn tonnes of grain that beat Soviet records.
The only prominent commentator that got close to predicting a deeper cut was Renaissance Capital, which released a note a day earlier entitled “More cuts coming”. But even Rencap was expecting the deeper cuts to come later, not this week.
“Our view is in line with Bloomberg consensus... We think that a 25bp rate cut should definitely be followed by another 25bp rate cut at the next meeting, on 9 February 2018. Having said that, there could be a chance that the CBR will cut rates by 50bp this Friday,” RenCap’s chief economist Oleg Kouzmin said in the note.
The investment bank argued that underlying the low headline inflation rate, “real” core inflation has also fallen to below 4%, below the CBR’s target rate, which justifies even deeper cuts than 25bp.
“Real core inflation indicators have also stabilised well below the 4% target: officially measured core inflation excluding food items and non-food price growth excluding gasoline were as low as 3.0% YoY and 2.5% YoY, respectively. We see no reason why this should change significantly, given the retention of relatively tight budget and monetary policies, and what we see as limited chances of the economy overheating and an exchange rate shock. In our view, this requires front-loaded policy easing, with a 7% rate (our view of the terminal rate of this monetary policy cycle) achieved in 3Q18,” according to Kouzmin, who previously worked for the CBR in its monetary policy department.
The analysts believe that the CBR was reacting to the current exceptionally low inflation and would prefer to cut sooner than later, so that it can retain its medium caution. The upshot is the rate of cutting in 2018 will be slower than in 2017 if the CBR’s inflation fears materialise.
“We still view a 7% rate (i.e. the higher bound of the neutral rate range) as the terminal rate of this monetary policy cycle, which we expect to be achieved in 3Q18. We do not want to say that the CBR will never arrive at a policy rate of 6.5% or 6% – but we think that should happen in another policy cycle, when the CBR gains confidence that consumer behaviour has changed and a low inflation environment remains sustainable,” Kouzmin said in his note, adding that the 6% rate is unlikely to appear until 2020.
While a lot of investment has been made into agriculture and the tonnage of grain from each harvest has been raising steadily there is no guarantee that 2018 will produce the same record beating result.
At the same time the crisis-hardened population remains skeptical of the current low rates. Polls have consistently found that Russians worry about inflation more than any other economic problem and the CBR surveys suggest the population is still using a working assumption that inflation will rise to 9% in the new year.
The CBR is more confident it can contain inflation and believes the rate will return to its target level of 4% in 2018.
But the authorities are in a rush to cut rates, which soared to 17% following the collapse of oil prices at the end of 2014 and the associated large devaluation of the ruble. The cost of money remains very high, which has depressed corporate borrowing and held back badly needed investment. Although fixed investment is up this year, it is almost all state investment, the bulk of which has gone into a few mega-projects such as the gas pipeline Power of Siberia to connect Russia with China and the construction of the Ketch bridge that will join the annexed Crimea peninsular to the Russian mainland.
In general, rate cuts will support growth which remains anaemic. The government was predicting 2% growth this year following almost three years of recession, but the October results disappointed and analysts are widely expecting the economy to finish 2017 with only 1.8% of growth. Going forward, unless the Kremlin launches a radical reform programme, Russia’s economy will be locked into similar low rates of growth for the foreseeable future.
The CBR said in its statement that it would probably continue cutting rates in 2018. The central bank has previously said it aims to bring its key rate down to 6.5-7% over the next two years as a sharp slowdown in inflation leaves room for cuts. The consensus forecast for rates at the end of 2018 is 6-7%, but that is already starting to look a bit conservative.
“The Bank of Russia will continue its gradual transition from moderately tight to neutral monetary policy and holds open the prospect of some key rate reduction in the first half of 2018,” the central bank said in a statement.