Russian consumer price inflation (CPI) ticked up to 2.5% in July, just below the consensus forecast of 2.6%, but is expected to continue to rise to the long-term trend level of 4% over the next year, the Central Bank of Russia (CBR) said on August 6.

“Due to the planned VAT hikes in 2019 (up to 20% from 18%), the CBR expects inflation to temporarily exceed 4% during the course of 2019. This is a one-off target overshoot that the CBR anticipates for next year,” analysts at TD Securities said.

Despite the rise from modern record lows of 2.2%, core inflation remains very weak, leaving the central bank the option to cut rates. The small rise in Russian headline inflation was largely driven by higher food inflation, say economists, while underlying price pressures are very soft.

However, following the government’s decision to increase VAT rate from 18% to 20% in July the CBR has become more cautious. Commentators like Capital Economics believe “the central bank will lower interest rates over the next 12-18 months or so” but the market consensus is for the central bank to tighten.

Low inflation has become a key data point as the Central Bank is targeting inflation over growth and the relatively tight monetary policy has held back growth to subpar levels.

In January-April overall, GDP growth is estimated at 1.3% y/y, flat as compared to the 1.3% y/y preliminary estimate for the first quarter. Currently the government still expects 2.1% GDP growth for 2017, with the CBR forecasting 1.5-2% growth and Reuters’ analyst survey showing 1.7% GDP growth expectations. Cutting rates would give the economy a shot in the arm but CBR governor Elvira Nabiullina has proven to be an ultra conservative central banker and refuses to cut.

Food prices accounted for the lion’s share of the price rises. “By our estimates, higher food inflation added 0.3 percentage points to the headline rate between June and July. Meanwhile, inflation in non-food goods ticked up, which was more than offset by a decline in services inflation,” Capital Economics said in a note.

However, while the VAT increase will add to inflation, Rosstat’s measure of core inflation, which excludes administered prices, fuel and some food products, only ticked up to 2.4% y/y, from 2.3% y/y, suggesting the inflationary pressures are still weak. Capital Economics said it is unlikely to rise as far as the 3.5-4.0% range the CBR expects by end-2018 and so expects one more 25bp cut this year from the current 7.25%.