Inflation is falling faster than expected. That has allowed the Central Bank of Russia (CBR) put in 300 basis points of rate cuts in the last two months and maybe another 300bp before the end of the year, bring down crushing interest rates that are doing real damage to the economy.

In remarks following last week’s 200bp rate cut that sets prime rate at, a still extremely high, 18%, CBR Governor Elvia Nabiullina said that economy is starting to come back on track, returning to “normal” metrics, but she remained extremely cautious and that there is both good news and bad. Russia's economy is not out of the woods yet. 

Russia’s Central Bank of Russia (CBR) has started easing monetary policy with a 200bp rate cut to bring down the price rate to 18% on July 25. That is welcome relief for companies that have been increasingly struggling to cope with sky high interest rates that have been eating into their profits. (chart)

CBR governor Elvia Nabiullina was upbeat in the press conference after the announcement, saying that inflation is falling faster than expected. RosStat reported that inflation has fallen from over 10% at the end of last year to 9.2% as of mid-July.

However, Nabiullina cautioned that while up to 300bp could be cut in the three monetary policy meetings left this year, there could also be no more cuts if inflation stops falling. However, July’s rate cut bodes well for the rest of the year and shifts the recession or if the economy is merely cooling debate currently raging amongst policy makers and economists to the “cooling” end of the spectrum.

Inflation coming back on track

Russia’s central bank decided to lower its key interest rate to 18% per annum but Nabiullina made clear that despite signs of disinflation, monetary policy will remain tight for an extended period to ensure a sustained return to price stability and the CBR’s ultimate target of 4% inflation.

“Inflation, including its underlying component, is decelerating,” Nabiullina told reporters in Moscow following the rate decision. “The growth of consumer demand is slowing down gradually, and the expansion of lending is moderate. All these factors allow us to further cut the key rate.”

Yet even as the CBR revised its end-year inflation forecast down to 6-7% from earlier projections, Nabiullina is still being famously careful. “We should therefore be prudent in making our further key rate decisions. Monetary policy should remain tight during a long enough period to ensure a sustained return of inflation to low levels,” she said.

Annual inflation stood at 9.2% in June, but underlying price growth slowed to an annualised 4-6% – an earlier deceleration than the bank had expected. However, the CBR governor noted that inflation remains uneven. “Price pressures remain elevated in services and most notably in public catering,” she said, citing structural shifts such as growing demand for domestic tourism and out-of-home consumption.

Prices for durable goods such as electronics and household appliances have fallen, reflecting the quicker transmission of high interest rates in that sector. “Interest rates impact prices through both a reduction in consumer lending and a stronger ruble,” she explained.

The bank also flagged risks from utility tariff increases, which could trigger second-round effects on inflation expectations. “A significant rise in prices for socially important goods or services can affect households’ inflation expectations,” Nabiullina said. “This in turn will be influencing their decisions on consumption and savings.”

It seems her unorthodox plan to bring down inflation by cooling the economy using non-monetary policy methods, launched last year, is working. But some analysts have likened the attempt as like trying to land and slow a plane with the throttle stuck on full (military spending) by not putting the landing gear down.

Nabiullina scored another victory as one of the major changes she made to cool growth was to cancel a generous mortgage subsidy programme last year that rocked the real estate market. However, as Vladislav Inozemtsev of the Centre for Analysis and Strategies in Europe just wrote for Riddle, an expected collapse of prices in the housing market failed to appear and the construction absorbed the shock well.

Russia’s chronic labour crisis is showing signs of beginning to ease, as new data show a slowdown in wage growth and hiring, particularly in the civilian and construction sectors, Kommersant reported this week.

According to a survey by the Institute of Economic Forecasting at the Russian Academy of Sciences, most employers no longer plan to raise salaries in real terms and new hires are slowing as economic cooling slows the demand for labour. While inflation has been running at around 10%, nominal wage increases have been higher at around 12% for the last two years leading to a strong increase in real disposable incomes that has been driving a consumption boom, but that growth is also already slowing, which will help reduce inflationary pressure.

Still problems to overcome

Despite the good macroeconomic news, the real economy is still suffering. Both the steel and coal sectors are in crisis and asking for government bailouts thanks to sanctions.

More recently, analysts have reported that the banking sector is also in danger of a crisis as the super-high interest rates slowly drive up non-performing loans (NPLs). NPLs have risen from around a comfortable 4% of the total loan book in December to a much less 10.6% for  corporate loans; consumer bad debt remains at a manageable 4%.

At here press conference, Nabiullina once again played down any problems in the bank sector: "We do not see any need for recapitalisation of large banks due to the potential overhang of bad debts. The banking sector is profitable."

And she is right: so far this year the bank sector is only slightly less profitable than last year, and last year banks earned a record RUB3.3 trillion ($36.6bn)  of profits. (chart) So far, whatever problems there are with overdue loans have not affected banks’ profits giving them ammunition to make provision for and cope with NPLs.

"I will say again that these are rumours that are not based on anything ... I can also give figures, because you need to look at the figures and the financial indicators. The banks are stable, they earn money, they have capital reserves. All this allows them to feel quite confident," she said. "We are keeping our finger on the pulse, but I do not see any reason to consider state support (for banks) in one form or another."

A race is on between the rate of monetary policy easing and the growth of bad debt. Some  analysts have  suggested that the biggest banks – Sberbank, VTB bank and Alfa Bank – may be forced to tap the state for a bailout, while other analysts say a crisis remain far away and point to the falling interest rates as easing the pressure.

The jury remains out, but Nabiullina remains a battle hardened veteran central banker, having navigated multiple crises since she took the job in 2013, and her unorthodox methods to bring down inflation are currently working well. However, true to form, she remains cautious.

While demand growth is moderating, and investment remains strong – particularly in government-supported sectors – the CBR remains concerned about structural labour shortages, Nabiullina says. “Staff shortages remain a risk factor for inflation,” she said during her press conference. “If the expansion of domestic demand accelerates again without a commensurate increase in productivity, it will largely translate into price growth.”

On the financial side, credit growth has slowed in line with expectations. Consumer lending continues to contract, while mortgage and corporate credit are expanding at a more modest pace. “Credit activity is affected by more modest demand for borrowing rather than by credit supply constraints,” she noted.

Nabiullina also cited external conditions, including a downward revision in the bank’s oil price forecast to $55 per barrel for 2025 and 2026. “Trade tensions between the largest economies will be weighing on external demand,” she said, while additional OPEC+ output is expected to add to global supply.

Despite these pressures, she noted that high interest rates continue to support the ruble, with domestic demand for ruble assets outweighing appetite for foreign currency holdings.

Looking ahead, the CBR is targeting a gradual path to normalisation, with projected average rates of 18.8-19.6% in 2025 and 12-13% in 2026. But the governor emphasised that the inflation target requires more than a few months of low readings. “The return to the target implies stabilising inflation at a sustainably low level, including both the actual inflation rate and inflation expectations,” she said.

“Monetary policy has ensured the reverse of the trend and inflation has started to decelerate,” Nabiullina concluded. “Therefore, monetary policy should remain tight for as long as needed to sustainably bring inflation back to 4% in 2026 and stabilise it close to this level.”