The Central Bank has already taken into account inflation expectations in the government

The decision of the Board of Directors of the Bank of Russia to raise the key rate by 0.5% was unexpected for the market. The Central Bank returned the cost of refinancing the banking sector to a level above inflation until mid-September 2014, anticipating possible changes by the government to its own policies. The further increase in rates, which the Central Bank promises to continue, is intended to reduce the pro-inflationary consequences of possible tariff and tax decisions of the Kremlin and the White House to maintain economic growth - the future semi-artificial “revival” of the economy in the second half of 2014 threatens with medium-term, rather than short-term problems.

Photo: Anton Belitsky, Kommersant / buy photo

The increase in the Central Bank's key rate at the regulator's board of directors on July 25 was unpredictable, although, according to Kommersant's information, the decision was made, as before, unanimously. Only the symbolic “refinancing rate” remained unchanged (8.25% per annum) - according to Kommersant, the council also decided to raise the Central Bank financing rate for investment projects by the same 0.5% (up to 50 billion rubles in 2014) and tie it to the key rate using the formula “inflation minus 1%”.

The key rate until September 12, when the next council meeting takes place, will be 8% per annum - de facto, the Central Bank returned the cost of refinancing for repo transactions obviously higher than the inflation rate (July peak - 7.8% year-on-year) and even with some reserve, taking into account possible risks of “increasing geopolitical tensions” (de facto weakening of the ruble in July-August in the event of further escalation of expectations related to international sanctions against the Russian Federation). The Central Bank in a press release following the council notes a “moderate recovery of economic activity”: an increase in rates in the standard logic of the regulator - an action designed to reduce excess and unjustified economic activity and inflation expectations, will further reduce GDP dynamics in the third and fourth quarters of 2014. The decision to increase rates will directly affect consumer inflation by the end of the year and until the end of the first half of 2015 - however, the Central Bank does not rule out a new rate increase even if the current situation remains unchanged “if inflation risks remain at a high level.”

The Central Bank provided part of the explanations for its decision in an immediate commentary, which mentioned “discussed changes in the tax and tariff policy” of the executive branch. Despite the fact that the likelihood of an increase in VAT or personal income tax from 2015 is still small (see page 7), in the first half of July information appeared in the White House about a possible revision of the decisions made at the end of 2013 on a new scheme for indexing tariffs of state monopolies as part of the budget preparation for 2015-2017. Let us remind you that core inflation is now 7.5%; the combination of factors ensuring its strong growth was not predicted by the Central Bank. Any decision that increases the “non-basic” component of the dynamics of the consumer price index and even the growth of inflation expectations from the unplanned increase in tariffs of state monopolies, even with strong anti-inflationary pressure (good harvest, reduction in the growth rate of lending to the corporate sector, stability of the ruble), will be translated into an increase in retail prices to end of the year.

At the same time, the Central Bank’s decision contains a broader response to the methods that the government and the Kremlin are likely to use in the coming months to maintain economic growth. Actual private demand for rubles with a stable exchange rate of the national currency (remember, the Central Bank has not intervened in recent weeks) over the next few months will be determined, on the one hand, by the duration of the closure of the “investment window” for banks and companies in the EU and the USA, the switching of state-owned companies to domestic Russian resources, political restrictions on imports, the pace of capital repatriation in the Russian Federation (factors of growth in domestic demand), on the other hand, a reassessment of the risks of new investment projects and flight from risks (factors of reduction in demand). The relatively high GDP growth in the second quarter of 2014 (1%), recorded by the Ministry of Economy at the end of June, may be only the beginning of a short-term “revival” of the economy with all types of soft government support - replacing foreign direct investment with quasi-budgetary ones, tariff and tax support for state-owned companies, investment by the National Welfare Fund and pensions reserves for infrastructure projects.

The Central Bank does not see direct signs of “bubbles” in the asset market - thus, according to Kommersant, the Bank of Russia is still quite calm about the increase in the residential real estate market in the first half of the year and the rapid growth of Sberbank’s mortgage portfolio. Nevertheless, the inflationary consequences of “rescuing” the economy according to this scheme are irrevocable, regardless of the period of “revival”. Obviously, the demonstrative increase in the rate shows the Central Bank’s readiness to prevent the economy from entering real, rather than theoretical, stagflation in 2015-2016 - the events of June-July 2014 brought the reality of such a scenario closer rather than further.

Dmitry Butrin

Unhealthy economic recovery