The Central Bank of Russia on June 10 cut its key interest rate from 11% to 10.5%, showing readiness to resume the monetary easing cycle that has been on hold since August 2015 as a result of the central bank's inflation-curbing efforts.
Analysts were evenly divided over whether the head of the CBR, Elvira Nabiullina, would make the long-anticipated move to cut the painfully high 11% rate as a way to help accelerate the return to economic growth that is widely expected for the second half of this year.
bne IntelliNews analysis suggested that as inflation has been largely tamed for now, the CBR's move to cut the interest rate will help the Kremlin in its third big structural reform drive, “Plan K”, led by former finance minister Alexey Kudrin, which will attempt to switch the economic growth driver from consumption to investment.
Despite some analysts warning that the CBR will be wary of a slight uptick in annual inflation acceleration expected in June-July, the central bank said in the June 10 press release that its “confidence in the stability of positive inflationary tendencies has increased”.
Sberbank CIB sees CBR's comments on inflation stabilisation as carrying an easing bias, albeit not a very strong one.
Both Alfa Bank and Sberbank CIB commented on June 10 that central bank's decision was a surprise.
Alfa argues that acceleration of budget spending growth, quickening of salary growth, uncertain fiscal outlook on 2017, as well as electoral cycle to start in September all have potential to be inflationary.
“All in all, it appears to us that the CBR decision was dictated by market trends rather than by improvement in internal fundamentals,” Alfa's chief economist Natalia Orlova writes.
“We had expected rates to be unchanged, in part due to the CBR's recent hawkish record. The most recent rise in the oil price and RUB may have provided it the confidence to move,” Tom Levinson of Sberbank CIB commented.
Inflation target, budget in check
One of the concerns has been that the Kremlin will boost social spending in the run-up to the September general election, which would stoke inflation.
But clearly Nabiullina has decided that with the budget deficit expected to be just under 4% of GDP by the end of this year, the Kremlin simply doesn't have the money for much vote-winning largesse and the danger of politically driven inflation remains small.
On the other side of the coin, with oil prices up to around $50, some of the pressure has come off the budget and created a little more wiggle room than was expected only a fwe months ago.
But referring to recent surprise data for first-quarter GDP and income, the CBR said that improving economic activity is not creating additional upward pressure on consumer prices. The central bank thus sees its target of curbing annual inflation rate to 4% by the end of 2017 as achievable.
The recent growing consensus on the recession being over by the end of the year is shared by the CBR: quarterly GDP growth is expected to resume no later than the second half of 2016, the statement reads, with a rebound to 1.3% growth for 2017 forecasted at $40/barrel oil.
Cautious for further cuts
However, despite the positive outlook, the CBR remains cautious and did not promise an unconditional resumption of the easy monetary cycle.
Inflationary expectations could reignite, the regulator warned, naming the absence of a mid-term fiscal consolidation strategy, uncertainty over pension and wages indexation, as well as global volatility as the main risk factors.
Thus, the CBR will watch those closely when evaluating whether there is room to cut the rate further at the next meeting of July 29.
“The CBR has taken a cautious first step and ultimately would not have done so if it did not believe it could continue,” Sberbank's Levinson argues.
Should external conditions remain stable and no upside risks to the 4% inflation target emerge, Sberbank even allows for four consecutive cuts by year end bringing the key interest rate down another 200bp.
The bank suggests to watch weekly inflation data towards the next meeting on July 27, while reminding that a Fed hike on July 27 could act to disrupt the CBR's next decision just two days later.
Alfa is more cautious, expecting the CBR to pause at its next policy rate meeting on July 29, especially if inflation remains above 7% for the coming months.
“At the same time, a substantial improvement in the oil price trend or a return of global risk appetite might play in favor of rate cuts starting fall this year,” Orlova believes.