At the Bank of Russia Board of Directors' meeting on 15 December, it was decided that the key interest rate should be radically reduced - by 0.5 pp. to 7.75%, and not by 25.5 pp., as had been presumed by the majority of experts.

 

However in our opinion, this decision can hardly be considered to be unexpected.

The Bank of Russia's current monetary policy can be characterized as moderately tough - that is, its aim is to play down the inflation and depreciation expectations. At the same time, consumer inflation has been hovering significantly below its target for quite a long time already, and any further slowdown in its movement is undesirable. The year-end result is unlikely to demonstrate any surge in its index above 2.5–2.7%, the official target being 4%.

Of course, this blatant deviation of the actual inflation index from its target value has been produced in the main by seasonal factors like the increased agricultural product supply as a result of this year's good crops coupled with the ruble's strengthening due to persistently (relatively) high prices of energy carriers. Next year, inflation will be getting closer to its target, but is still unlikely to jump above it in absence of any strong negative shocks. In such a situation, a more rapid switchover to a neutral monetary policy appears to be quite justifiable. It is true that inflation expectations are still significantly above the target level, but they also continue to decline; meanwhile, as demonstrated by world experience, inflation expectations practically always hover above inflation targets.

The Bank of Russia's confidence has probably been further boosted by the extension of the OPEC deal to cut oil production, which has increased the likelihood of high prices of oil to persist over the course of next year, thus ensuring the ruble's exchange rate stability. Economic revival also continues roughly at the same rate as potential GDP – that is, at about 2% per annum. We believe that the Bank of Russia will continue its monetary policy easing, gradually bringing the key rate to a neutral level of 6–7% over the next 1.5–2 years. However, the regulator must closely monitor potential risks, one of which might be the introduction of new tough economic sanctions against Russia with the resulting weakening of the national currency.

Pavel Trunin - Doctor of Economic Sciences, Director of the Center for Macro-Economics and Finance