To Keep the Key Interest Rate at Its Current Level Appears to Be a Reasonable Decision

At the Bank of Russia Board of Directors' meeting last Friday, it was decided that the key interest rate should be kept unchanged. The key interest rate is to stay at 11% until the Bank of Russia Board of Directors' meeting scheduled for 29 January 2015.

The regulator explains this decision by the fact that the pro-inflation risks are currently being set off by the economic cooling risks, so there are presently no reasons either for softening or toughening Russia’s monetary policy. The estimates released by the Bank of Russia indicate that Russia’s economy is likely to be nearing the bottom of its current crisis, and it is likely that, by mid-2016, a gradual revival of the investment and production activity will be observed.

The regulator expects that, from January 2016 onwards, the inflation rate will begin to significantly slow down, and that the year-end CPI for 2016 will be at around 6%. If the real situation should indeed develop in accordance with that scenario, the monetary authorities will reduce the key interest rate at one of its next meetings. By acting in this way, the Bank of Russia sends a signal to market participants that it is going to ease its monetary policy alongside inflation decline and stabilization. Inflation decline over the course of next year indeed appears to be quite probable, because by that time the effects of the ruble’s depreciation, which represent a major inflation factor, are expected to wear off.

However, the Bank of Russia forecast based on the expectations of a sharp decline in the price growth index appears to be too optimistic. The regulator’s tendency to underestimate the inertia of the inflation processes is further confirmed by the statement, in its official press release, that the currently observed decline in the inflation rate has been proceeding at a slower pace than initially expected, and that the inflation expectations have been on the rise, contrary to their expected reduction.

We believe that at present, the inflation risks prevail over the deflation risks, because the new plunge of oil prices, the expected increase of the key rate by the US Federal Reserve, and the slowdown in China’s economic growth rate will all combine to increase the downward pressure on the ruble’s exchange rate against world major currencies, thus triggering a new inflation surge.

And on the other hand, the shrinkage of aggregate demand, with its downward pressure on the price index, has become slower, and so the suppressive effects of the factors that determine the movement of the inflation rate are by no means strong. Nevertheless, the inflation risks are not yet so strong as to justify the raise of the key rate, and so the decision that it should be kept at its current level appears to be quite reasonable.

Yevgeny Goriunov – Researcher, Monetary Policy Department