Russian inflation will rise to 3.2% in 2018 on higher food prices, Sberbank said at the end of March.

Inflation dropped to a record low of 2.2% y/y at the beginning of the year, coming well short of the official year-end target of 4%.

“The 5.4% inflation of 2016 now seems a distant memory. The main reasons for the sharp downturn in inflation were the strong ruble, good harvest and sluggish domestic demand. However, we expect some of these factors to reverse this year, and we see inflation climbing to 3.2% y/y by year-end, mainly driven by higher food inflation. Yet that would still be well below the target,” Sberbank CIB said in a note.

Inflation came in at 2.5% y/y in December before easing further to 2.2% y/y in January and February. This was the result of several factors, including the stronger ruble, a good harvest and increased food production, as well as weak domestic demand in 2015-16. Some of these factors have started to fade or have even reversed, so Sberbank expects inflation to accelerate to 3.2% this year, with rising food inflation the key driver. This would represent a normalisation from the current unusually low levels but would still remain below the official target of 4%.

Food disinflation was an important factor driving down inflation in 2017 but is set to reverse this year, added Sberbank.

“Food inflation slowed to 1.1% in 2017 from 4.6% in 2016, and as a result its contribution to inflation declined from 1.7 pp to just 0.4 pp. However, this year food inflation is set to accelerate again, and we project it to reach 4%, taking its contribution to headline inflation up to 1.5 pp,” the bank said in a report.

Domestic demand recovery, which is rising on the bank of improving real incomes, will drive prices higher. Weak domestic demand during 2015-16 was an important drag on inflation. However, household consumption has started to recover, supported by rising real disposable incomes and wages, so it is poised to again become a pro-inflationary factor.

Against that, the supply factors are to remain largely positive, limiting price growth. Domestic food producers have become more competitive since the sharp drop in the ruble in 2014 and the ban on food imports from certain countries. Coupled with good weather, this has considerably boosted output in the agricultural and food manufacturing sectors. It is clearly impossible to predict the weather, but food production and agricultural output look set to continue growing – partly thanks to massive state investment — which will limit upward pressure on food prices from the supply side.

“[G]lobal factors should prove neutral this year. The strong ruble and depressed global food prices were important factors limiting food inflation last year, but we expect them to have a mostly neutral impact this year. We expect a slightly weaker nominal effective exchange rate this year (due to the budget rule), but this should have only minor effect on inflation. We expect global food prices to remain largely flat,” Sberbank said.