Bank of Russia’s Dovish Surprise Brings Rate Below Pre-War Level

(Bloomberg) — Russia’s central bank brought interest rates below their level before the invasion of Ukraine, seizing on steep slowdown in inflation to ease monetary policy more than forecast.

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Policy makers lowered their benchmark to 8% from 9.5% on Friday and signaled they will consider further reductions in the second half of the year. The fifth straight cut was bigger than predicted by any of the economists surveyed by Bloomberg.

The ruble extended its drop against the dollar after the announcement and weakened as much as 2.6%. Speaking to reporters in Moscow, Governor Elvira Nabiullina said broad-based declines in prices and falling inflation expectations motivated the decision.

“Incoming data indicate that the economic downturn will be more prolonged in time and possibly less deep,” she said. Among the three easing options it considered, the central bank opted for the deepest rate cut, she said.

The easing cycle that started in April has taken advantage of a slowdown in inflation after rapid gains in the ruble and a steep cooling of the economy. Although central bankers from Europe to South Africa are unleashing the most aggressive tightening of monetary policy in decades, Russia’s isolation from global markets makes it more immune to the narrowing in the rate differential.

“The central bank decided to be pro-active — no one expected it to such an extent,” said Dmitry Polevoy, economist at Locko-Invest. Now it “take a break, monitoring further trends.”

Economy, Sanctions

The economy appears on track for a much shallower recession than first feared, boosted by fiscal stimulus and rising oil production that has blunted the impact of US and European sanctions over the Kremlin’s war in Ukraine.

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Driven by the sanctions imposed by the US and its allies, imports into Russia have all but collapsed, contributing to a record surplus in the current account. With trade imbalances growing worse, lower interest rates may bring some relief for consumers and help revive domestic demand.

What Bloomberg Economics Says:

“Persistent ruble strength, declining inflation expectations and faltering bank lending likely drove the decision. The central bank is likely to further cut the policy rate to 7.5% by the year-end, in a series of shrinking cuts.”

–Alex Isakov, Russia economist. For full React, click here

The Bank of Russia released new projections on Friday, showing it expects the economy to contract 4%-6% this year, down from its earlier prediction for a drop of 8%-10%.

Other highlights of new projections:

• The central bank upped its forecast for the current-account surplus this year to a record $243 billion from the $145 billion it expected in the spring, thanks to higher exports and lower imports

• The Bank of Russia also improved its inflation outlook and now anticipates price growth will end the year at 12%-15%; its earlier prediction was for 14%-17%

• It sees the key rate averaging 10.5%-10.8% this year and at 7.4%-8% from July 25 till year end

Annual price growth eased to 15.4% as of July 15, down from nearly 18% in April. Inflation expectations for a year ahead have also declined to levels last seen in March 2021.

“It was a notable surprise,” said Sofya Donets, economist at Renaissance Capital. “The bigger-than-forecast easing was supported by lower inflation expectations in July — data that the market didn’t get to see before the week of silence.”

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