Summary
Central Bank of Russia (CBR) raised deposit rate from 3.25% to 3.5% on its rate setting meeting on May 30. It left refinance and REPO rates on hold at 8.25% and 5.5%, respectively. The CBR said that there was balance achieved between inflation risks and risks of economic growth slowdown at present, which was conducive to leaving all the policy rates on hold in the coming months. It effectively signals about completion of the monetary policy tightening. Further to the CBR’s statement, we revise our policy rate projections seeing refinance rate and repo rate peaked at the current levels of 8.25% and 5.5%, respectively, rather than 8.5% and 5.75% before.
Facts
The Central Bank of Russia (CBR) raised the deposit rate from 3.25% to 3.5% in its rate setting meeting on 30 May. It left refinance and REPO rates on hold, at 8.25% and 5.5%, respectively. The CBR said that balance had been achieved at present between inflation risks and risks of economic growth slowdown, which was conducive to leaving all policy rates on hold in the coming months. It thus effectively signalled the end of monetary policy tightening. In line with the CBR’s statement, we revise our policy rate forecasts, and see the refinance rate and repo rate at the current levels of 8.25% and 5.5%, respectively, by the year-end, rather than at 8.5% and 5.75%, as expected before.
Reserve requirement ratios (RRR) were left on hold as well. The accompanying policy statement referred to still-high inflation expectations that exceeded the official target for the year. The CBR also mentioned that softer-than-expected April economic data show “substantial risks persist to economic growth”.
Implications
Although all the rate and RRR decisions were in line with our expectations, we see two things in the CBR’s policy statement that should surprise markets. First, the 25bp hike in deposit rates was only partially anticipated by the market (45% of the Bloomberg poll). Second, the CBR has clearly stated that it does not intend to hike rates anymore in the near term. This is in a sharp contrast with prevailing market expectations of about 25bp more tightening in June/July before the tightening cycle is over. We commented extensively on the drivers for this mixed decision on policy rates in our MPC meeting preview in our daily note on Friday (CBR MPC Preview: Refinance and repo rates – on hold, deposit rates – up 25bp).
While the element of surprise in the 25bp deposit rate hike may trigger some immediate appreciation pressure on the RUB, the strong signal about a completion of the tightening cycle should play against the RUB, we think. At the same time, stabilisation of CBR’s repo rates should be a positive factor for local bonds, as would any improvement in RUB liquidity following the CBR’s bill repayments in mid-June.
From a macroeconomic perspective, the CBR’s belief of the appropriateness of the current policy rate levels for the economic growth/inflation mix leaves very little room for rate hikes down the road, beyond the next few months. Even if inflation starts surprising on the upside on the back of a rebound in domestic demand, it would be difficult for the CBR to argue for policy tightening in an environment of declining y-o-y inflation (thanks to the base effect), especially taking into account the approaching elections. Effectively, it means that the CBR will not be hiking rates (except, possibly, deposit rates) any further in this cycle.
However, we see some risks attached to this policy. Higher inflation expectations backed by stronger domestic demand and some currency weakening have the potential to keep inflation above the levels the authorities would like to see in 2011-12. In addition, by conserving negative real interest rates on household deposits, the CBR should be prepared for further deceleration in the deposit growth rate and for banks’ to resume hunting for funding from overseas. Finally, insufficiently high RUB interest rates may sustain the asset switch to FX holdings (cash and deposits) that has emerged recently. As such, the policy could end up supporting capital outflows, which would be negative for the RUB in the medium term.
Taking into account the CBR’s statement, we revise our policy rate projections, expecting that the refinance rate and the repo rate have now peaked at the current levels of 8.25% and 5.5%, respectively, rather than rising to 8.5% and 5.75%, as expected before. We still see the possibility of a 25bp hike in the CBR deposit rates in 4Q11, provided strong RUB depreciation pressures emerge by then. As before, we expect the CBR to start cutting policy rates in 4Q12.
Bottomline
The CBR considers its job done in this part of the policy cycle. It could be right but it could be wrong too.
HSBC Global Research