The Bank of Russia cut its key rate by 50 basis points to 7.75 percent.

On December 15, 2017, the board of directors of the Russian Central Bank decided to cut the key rate from 8.25 percent to 7.75 percent per annum. In its decision, the regulator announced that inflation holds at 2.5 percent and will gradually draw near four percent by late 2018. The extension of the agreement to reduce oil production brings pro-inflationary risks down over a one-year horizon. In the bank’s assessment, medium-term pro-inflationary risks still prevail over the risks of inflation’s sustainable deviation downward from the target. The Bank of Russia will continue its gradual transition from moderately tight to neutral monetary policy.

Moving forward, the bank’s key rate decisions will be based on its assessment of the balance of risks of inflation’s material and sustainable deviation in either direction from the target, as well as the dynamics of economic activity against the forecast. The Bank of Russia holds open the prospect of some key rate reduction in the first half of 2018.

In making its key rate decision, the Bank of Russia recognized such factors as inflation dynamics, monetary conditions, economic activity, and inflationary risks.

Regarding inflation dynamics, under the impact of temporary factors, annual inflation holds below three percent. As of December 11, 2017, it was estimated at 2.5 percent.

In the fourth quarter of 2017, increased supply of farm produce on the back of growing crop productivity and the shortage of long-term storage facilities continued to exert a downward pressure on consumer price growth. As a result, annual food inflation fell to 1.1 percent in November 2017. The majority of factors associated with the 2017 harvest will cease to have a disinflationary influence in the first half of 2018. The contribution of the exchange rate dynamics to annual inflation slowdown diminishes and will be exhausted in the first quarter of 2018.

The annual price increase for non-food products, which stood at 2.7 percent in November, is decelerating, while costs of services went up by 4.2 percent over the year. According to the Bank of Russia’s estimates, the majority of annual inflation indicators reflecting the most sustainable price movements are somewhat below four percent. The slowdown of inflation was conducive to a decline in inflation expectations, which nevertheless remains unstable and uneven. The annual inflation is expected to be under three percent in late 2017 and close to four percent by late 2018, as the impact of temporary factors is exhausted.

Relative to monetary conditions, the Russian Central Bank observed that the key rate decision and the potential for its decrease in the future will contribute to further easing of monetary conditions. This development, in its turn, will cause inflation to approach four percent. While nominal bank rates keep declining, real bank rates remain in the positive territory. Non-price lending conditions are gradually becoming looser for the most reliable borrowers, but are still restrictive. The bank’s analysis points out that in the course of the transition to neutral monetary policy, the shape of the yield curve will continue to change from inverted to normal. The potential for lowering the short-term rates is greater than long-term rates.

The Central Bank believes that existing conditions encourage savings and ensure that consumption growth is balanced. The bank’s research suggests that the trends will persist amid further gradual easing of the monetary policy and the low-risk appetite of lenders and borrowers.

On economic activity, the Bank of Russia estimates that by the end of 2017, the economy’s growth rate will be close to its potential at 1.7 to 2.2 percent. Therefore, monetary conditions generate low inflationary pressure without restricting economic growth.

In view of the extension of the agreement to reduce oil production, the Bank of Russia has raised its GDP growth forecast for 2018 in comparison to the previous baseline scenario. However, the medium-term prospects of the Russian economy saw no changes. Over the forecast horizon, economic growth will not exceed 1.5 to 2.0 percent, which corresponds to the current estimates of its potential level.

In reference to inflation risks, the Russian Central Bank observed that a number of factors may cause inflation to deviate from the target both upwards and downwards. They include the dynamics of food and oil prices, which are characterized by high volatility. The fiscal rule will set off the impact of the oil market conditions on inflation and the domestic economic environment as a whole. At the same time, certain factors generate mostly pro-inflationary risks: this includes the situation in the labor market, potential changes in the consumer behavior, and the nature of inflation expectations.

The extension of the agreement between oil-exporting countries lowers the uncertainty of the energy prices’ dynamics and the related pro-inflationary risks over a one-year horizon. However, risks of inflation’s upward deviation from the forecast in the medium term still prevail. First, increased structural labor shortage may cause labor productivity growth to considerably lag behind the wage growth. Second, inflationary pressure may stem from changes in the households’ behavior as the propensity to save becomes much lower. Third, inflationary expectations remain elevated and subject to fluctuations caused by movements in prices of certain goods and services and the exchange rate. Besides, the medium-term balance of risks for inflation dynamics will depend on potential budgetary and tariff decisions to be made in 2019 and 2020. The Bank of Russia will also monitor risks posed by external factors all over the forecast horizon.

The Bank of Russia Board of Directors will hold its next rate review meeting on February 9, 2018.