(Bloomberg) -- The Bank of Russia is poised to decide how high to raise interest rates, as initial plans to start easing monetary policy in the second half of the year fall by the wayside after an expected slowdown in inflation never materialized.
Instead, price growth has accelerated, moving even further away from rate-setters’ target of 4%. The central bank’s decision to hold the benchmark at 16% after its June meeting has exacerbated the problem.
Most economists surveyed by Bloomberg forecast a sharp rate hike of 200 basis points to 18% at the meeting Friday, while two others expect an increase of half that much. None of the 14 analysts surveyed project a hold.
The Bank of Russia’s decision to forgo a June rate increase “means a larger hike in July,” Russia economist at Bloomberg Economics, Alex Isakov, said. “Inflation overshooting 4% in 2024 has become unavoidable — despite the central bank’s recent vocal commitment to bring it back to the target over the course of the year.”
The central bank admitted in a recent report published ahead of the upcoming meeting that monetary conditions would need to be tighter in the second half of the year to return inflation to their goal.
Since the June rate decision, price growth has spiked, driven by demand that’s persistently outpacing supply as well as one-time factors beyond the central bank’s control. Prices for vegetables skyrocketed last month instead of declining as was usual in previous years during summer. Due to unexpected frosts that destroyed crops, seasonally adjusted food inflation reached 12.3% in June compared to 8.3% in May, according to the Bank of Russia’s estimates.
Growth 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.
Meanwhile, the economy remains overheated by the war in Ukraine, and demand for labor has reached a historic peak. Higher incomes have boosted demand for tourism this summer, despite the ongoing military conflict, making the cost of travel among the fastest growing.
“The rhetoric will be as harsh as possible” at the approaching meeting, said Natalya Vashchelyuk, a senior analyst at First Asset Management JSC in Moscow. Apart from raising the rate by two percentage points, “most likely the regulator will report that the period of high rates will be longer than expected at the June meeting,” and another hike won’t be excluded, she said.
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.
While a hike in the key rate is all but inevitable, questions remain whether one increase will be enough.
“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.”
What Bloomberg Economics Says...
The risks are skewed in favor of a larger hike, which will be followed by a cut back to 16% as early as December 2024. Provided the government continues to scale back reduced-rate mortgage lending and other subsidized lending, we expect the 18% policy rate to be sufficient to slow credit growth visibly toward the end of 2024.
—Alex Isakov
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.
“Raising the key rate to 18% may be enough to return inflation to the target level of 4% by the end of 2025, but pro-inflationary risks and uncertainty remain high,” Vashchelyuk said. “It is possible that an additional hike will be required.”
©2024 Bloomberg L.P.
