EEMEA | Monetary Policy & Inflation
After a recent U-turn in their rhetoric, we expect the CBR to follow other major EM central banks (Brazil, Turkey) and hike the policy rate at Friday’s meeting (19 March). The CBR statement turned more hawkish at the last meeting on 12 February and clearly signalled that the easing cycle had ended. Its updated inflation forecast raised the range for headline inflation at end-year to 3.7-4.2%.
Headline inflation rose in the past few weeks. In February, consumer prices were up 0.8%MoM, vs 0.7%MoM in January, raising the YoY rate by 0.5pp to 5.7% (Chart 1). Against seasonal trends, inflation accelerated across the main categories: food prices from 1.0%MoM in January to 1.2%MoM in February; non-food goods from 0.53% to 0.58%; services from 0.38% to 0.44% (Chart 2). Core inflation also increased in February to 0.58%MoM and 4.9%YoY (vs 4.6%YoY in January). Weekly CPI inflation remained at 0.2%WoW from 2 February to 9 March and then slowed to 0.1% from 10 to 15 of March.
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Summary
- I expect the CBR to hike its policy rate by 25bps to 4.50% on Friday and follow with further tightening in 2Q this year.
- Accelerating inflation, an ongoing recovery in domestic demand and hawkish CBR rhetoric all argue for a hike.
- RUB appreciation, declining inflation expectations and concern that higher lending rates could stall the recovery leave risk the CBR could wait.
CBR at a Turning Point
After a recent U-turn in their rhetoric, we expect the CBR to follow other major EM central banks (Brazil, Turkey) and hike the policy rate at Friday’s meeting (19 March). The CBR statement turned more hawkish at the last meeting on 12 February and clearly signalled that the easing cycle had ended. Its updated inflation forecast raised the range for headline inflation at end-year to 3.7-4.2%.
Headline inflation rose in the past few weeks. In February, consumer prices were up 0.8%MoM, vs 0.7%MoM in January, raising the YoY rate by 0.5pp to 5.7% (Chart 1). Against seasonal trends, inflation accelerated across the main categories: food prices from 1.0%MoM in January to 1.2%MoM in February; non-food goods from 0.53% to 0.58%; services from 0.38% to 0.44% (Chart 2). Core inflation also increased in February to 0.58%MoM and 4.9%YoY (vs 4.6%YoY in January). Weekly CPI inflation remained at 0.2%WoW from 2 February to 9 March and then slowed to 0.1% from 10 to 15 of March.
Conversely, the population’s inflation expectations started declining in February. Household inflation expectations 12-months forward lowered to 9.9% from 10.5% in January and perceived inflation to 12.3% from 12.8%. The CBR watches inflation expectations as one important indicator.
CBR – Return to Target Possibly Delayed
The CBR noted in its 11 March commentary that February’s price trajectory was above the latest CBR inflation forecast. It also noted that one-off factors contributed to the food price dynamics, including the ‘epizootic situation’ (the bird flu outbreak) that affected poultry and egg prices. Consequently, the regulator noted, ‘annual inflation slowdown to 4% may be delayed until early 2022’.
A more hawkish tone is also evident in CBR commentary. Governor Elvira Nabiullina said in a 12 March interview with Izvestia newspaper that the CBR does not exclude a rate hike in 2021 and clarified that the policy rate might return to the neutral range of 5-6% within the CBR’s forecast horizon of 2021-23. On 10 March, another CBR official said that the monetary stance is to remain loose ‘on average’ this year. These announcements allow the CBR to hike its policy rate by 50bps in 1H this year and still keep it below the ‘neutral’ range of 5-6%.
President Vladimir Putin may also be preparing to announce pre-election handouts, which CBR officials could know about. Parliamentary elections are scheduled for September, and United Russia’s rating dropped during the Covid-19 epidemic. All eyes will be on Putin’s annual address to the Federal Assembly, which usually happens around March. The date is still unconfirmed, but Putin’s press secretary said it is delayed.
Bloomberg consensus is for rates on hold on Friday, with only three analysts (including myself) expecting a hike. The implied one-month rate is at 4.49%, showing that the market has almost fully priced in a 25bp hike.
Does the CBR have enough reasons to hike its policy rate now, or should it wait for greater clarity on inflation pressures and government spending plans? Here are the pros and cons of tightening now:
Pros:
- Inflation is above the latest forecast and may miss the end-year 4% target.
- Recent hawkish CBR rhetoric has arguably prepared the market for a hike.
- Nominal and real wage growth is strong (and overall the demand recovery seems solid.
- GDP data were stronger than expected last year, as Russia eschewed lockdowns in 2H.
- With the economy past the worst, the CBR must start normalising its monetary policy.
- With rising US Treasury yields, EM central banks need higher nominal interest rates to keep EM assets attractive for foreign investors.
- A hike would silence those critics worried that a mortgage bubble might be developing and calling on CBR to reign in the mortgage lending boom.
Cons:
- Food prices are the main driver of the inflation overshoot.
- Inflationary expectations peaked in January and have since declined sharply.
- Base effects will kick in from April, bringing YoY inflation down.
- Pass-through from last year’s RUB depreciation is petering out, and with Brent nearing $70/bbl, RUB has strengthened.
- Neither the government nor president has unveiled measures yet that could boost consumer demand and increase inflationary risks.
- Russia has vaccinated ~3% of the population, exposing it to a third COVID wave.
- Most business support measures expired at the end of 2020. A rise in lending rates could slow the recovery.
- If the recovery stalls, the CBR could face blame for tightening its policy too early.
The CBR is known for conservatism, and its officials have already hinted that tightening is on the cards. With strong signs of recovery and inflation above target, tightening would make sense.
There is still a chance, of course, that the CBR decides to wait until its April meeting to see if inflation continues to deviate from its seasonal path. However, I think the CBR has nothing to gain from waiting. Nabiullina recently indicated that the CBR would move in small steps, making a 25bp hike more likely than a 50bp one.
My base case is that the CBR will hike its policy rate 25bps to 4.50% on Friday and follow up with further tightening in 2Q this year.
Tatiana Orlova holds a MSc in Economics from the LSE and has worked as an Emerging Market economist and strategist since graduation in 2001. She has been employed in EM research teams in four investment banks covering a diverse range of CEEMEA economies, with a particular specialism in the post-Soviet economies.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)