(Bloomberg) -- Russia’s central bank raised interest rates for the first time this year, as six months of acceleration in price growth forced policymakers to pivot from plans to start easing in the second half of the year.
The Bank of Russia raised its benchmark on Friday to 18% from 16%, in line with most forecasts. In a statement accompanying the decision, policymakers said they “will consider the necessity of a further key rate increase at its upcoming meetings.”
“For inflation to begin decreasing again, monetary policy needs to be tightened further,” the central bank said. “Returning inflation to the target requires considerably tighter monetary conditions than presumed earlier.”
Policymakers are having to contend with domestic demand that’s persistently outpaced supply, an economy that the Kremlin’s war on Ukraine has caused to overheat and an unprecedentedly tight labor market. Price growth in Russia has accelerated since the central bank kept rates on pause in June, moving even further away from its target of 4%.
One-time factors beyond the central bank’s control have contributed to stronger price pressures, such as unexpected frosts that destroyed crops and helped drive food inflation to an estimated 12.3% in June compared to 8.3% in May.
The Bank of Russia acknowledged in a recent report that monetary conditions would need to be tighter in the second half of the year to return inflation to its goal.
The central bank also revised its medium-term outlook on Friday and now expects a higher path for prices.
It projects annual inflation at 6.5%-7% at the end of this year as opposed to 4.3%-4.8% forecast earlier. The bank, which previously saw inflation returning to its target at the end of 2024, now doesn’t exclude possibly missing its goal even at the end of next year.
Speaking after the decision in Moscow, Governor Elvira Nabiullina said the central bank has no plans to cut rates this year and its hike aims to prevent the possiblity of stagflation, or high inflation coupled with low economic growth.
“Today’s additional tightening of our policies will prevent such a scenario,” she told reporters. “The economy remains significantly overheated.”
What Bloomberg Economics Says...
“Absent any surprise public spending increases, tightening of sanctions on Russia’s access to imports or a drop in export revenue, the Bank of Russia may start reducing the policy rate as early as December 2024.”
—Alex Isakov, Russia economist. Click here to read more.
Gains in fuel costs increased in momentum due to seasonally high demand amid the repair of many oil refineries damaged by Ukrainian drones. A stronger ruble — usually a factor that softens inflation by making imported goods cheaper — was undermined by new US sanctions that drove up payment costs for Russian importers.
“Difficulties with cross-border payments create pro-inflationary risks that outweigh the disinflationary impact of the ruble strengthening,” the central bank said, pointing to issues with imports as one of the key reasons for an increase in price growth in several regions.
Higher incomes have boosted consumer demand, including for tourism this summer. That’s made the cost of travel among the fastest growing categories.
Inflation expectations among businesses and households also grew, with the 12-month gauge — closely watched by the Bank of Russia — surging this month to 12.4% from 11.9% in the previous month.
Moving forward, the bank will have to assess whether one increase will be enough amid the torrent of inflationary pressures.
For now, the second half of the year looks easier to navigate for policymakers.
Credit expansion is likely to slow further thanks to high rates and the end of a subsidized mortgage program. A cooling economy may also bring relief to the labor market, while fuel prices may stabilize once refinery repairs are complete.
But spillovers into the economy from the war won’t be easy to overcome.
“This hike won’t help much in the fight against inflation, but the central bank can’t do nothing,” said Natalya Zubarevich, a specialist on Russia’s regions at Moscow State University. “As long as budget funds are rapidly injected into the economy, primarily into the defense sector, it will be extremely difficult to fight inflation, even by raising the rate.”
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