The Bank of Russia Reduced the Key Rate Despite High Inflationary Expectations

Last week the Bank of Russia took two important decisions regarding the monetary policy: first, from 28 July onward purchases of foreign currency to replenish international reserves were halted, and, second, from 3 August the key rage was reduced by 0.5 p.p. from 11.50 to 11.00 per cent per annum.

According to the official press-release of the Bank of Russia, decision to reduce the key rate was conditioned by risks shifts towards the considerable economy cooling. At the same time, the Bank of Russia Board of Directors stresses that currently there are additional inflation risks, namely, ruble devaluation happened in the second half of July due to crude price fall and recent increase in utility tariffs on housing services. Nevertheless, the governing body of the regulator considers justified moderate easing of the monetary policy.

It should be noted, that at the previous meeting of the Bank of Russia Board of Directors held on 15 June, the key rate was reduced as well. At the same time, it was declared that further reduction of the key rate would be limited by inflation risks. Taking into account the fact that currently there is a stable trend towards slowing down of consumer prices and inflation as of the end of July constituted 15.8, the latest decision regarding reduction of the key rate seems to be premature and contradicts previous statements made by the Bank of Russia. Of course, in its decisions the Bank of Russia should follow not so much the current rate of inflation as the anticipated rate of inflation. However, the latest estimates of the inflation expectations of the Bank of Russia constitute 12.5% against 11.9% in April.

We consider that the reduction of the key rate looks especially strange taking into consideration the ruble weakening happened in July which can result in inflation spiraling in H2 2015. Of course, we can interpret the halt of replenishment of international reserves as an attempt of the Bank of Russia to support the ruble exchange rate, in other words, as an element to target the exchange rate. Taking into account an insignificant amounts of foreign currency purchases ($200mn per day) this decision means, most likely, a symbolic effect proclaiming that the Bank of Russia considers the scale of the ruble weakening excessive.  

However, this measure openly contradicts previously made declarations of the regulator regarding replenishment of the international reserves which would be neutral towards the exchange rate. In other words, the policy of replenishment of international reserves which is practiced by the regulator contradicts the exchange rate free flow regime which is falling due to deterioration of the terms of trade of the Russian Federation.

Evgeny Goryunov – researcher of the Budget Sustainability Department