Russia: CBR likely to pause in July

Russia financial conditions have been changing as global oil prices have declined rapidly in recent months, down nearly 25% since early May. The RUB has accordingly been hit, down 22% since mid-May and depreciating more than 5% this past week alone. This tips the balance in favour of a more cautious monetary policy. The RUB vulnerability and its possible impact on inflation make it unwise for the Bank of Russia (CBR) to cut its key rate at this time.

The financial risks from the RUB depreciation for monetary policy are significant. The RUB depreciation that has already taken place could add to inflation, it is estimated that, a pass-through of about 20% during periods of one-way RUB sell off. Further, if oil prices continue to decline, as is possible, the RUB could be vulnerable to overshooting, as happened in separate incidents in December 2014 and January 2015. Oil prices are already lower than January levels and could drop further. Currency overshoot would put considerable strain on the financial system and probably cause further declines in growth, says Barclays.

There are several supporting factors that weigh in favour of keeping the key rate on hold this month, First, in mid-May the CBR initiated daily FX purchases and since then has added about $1bn to its reserve each week. This is putting a strain on the availability of FX on the market, weakening the RUB further. The CBR appears quite determined to keep its FX purchase programme in place and would probably prefer to keep interest rates higher than to forego the daily purchases.

Second, the CBR has already reduced its key rate considerably, by 550bp since January to 11.5%. While further interest rate cuts could help the economy recover, it is doubtful that a delay of a few months will have a large effect on economic growth. Pausing in July will give the CBR more time to assess financial market trends. If the RUB were to stabilise and inflation were to drop more than expected, the CBR could react later by cutting interest rates more rapidly. If instead oil prices continue to fall and the RUB is under more pressure, the CBR could remain on hold for more meetings to help support the RUB and limit the inflation pass-through.

"Another consideration is that the government has increased utility prices this month by an average of 7.5%, causing a temporary increase in the level of inflation. It is predicted that, July inflation will accelerate to 15.9% y/y (from 15.3% in June) following three months of declines. While it is expected that, the increase in inflation will prove to be temporary, it is likely to have a negative impact on inflation expectations. A pause by the CBR would be a signal to the market that the CBR is serious about bringing inflation down. It is believed, the pause will not signal an end to the rate-cut cycle. The CBR will cut its key rate during the upcoming year and could resume cuts as early as its next meeting in September", notes Barclays.