Bank of Russia likely to keep key rate on hold in 2016 on elevated inflation risks, vulnerable ruble

The Bank of Russia is expected to keep its key rate on hold at 11% on 18 March, after it lowered the rate by 600bps in 2015. The authorities would like the central bank to further ease policy due to weak domestic demand and the ruble strengthening quite bit. But the currency is expected to depreciate again in the near term because of lower oil prices, normalization of US Fed policy and external debt repayments. Russia's inflation outlook faces risks on the upside from the vulnerable ruble.

On fundamental basis, resumption of rate cuts can benefit domestic demand. The Economy Ministry had recently reported that the Russian GDP contracted 2.5% y/y in January after shrinking 3.5% y/y in December, whereas the real disposable income fell 6.3% y/y after a -0.8% y/y print in December. Moreover, the recent manufacturing PMI survey highlighted the sector's fragility with the PMI falling to 49.3 in February. The Russian GDP is likely to contract by around 2% in 2016 due to lower oil prices and the hampered access to capital markets because of sanctions.

However, the central bank's First Deputy Chairwoman Yudayeva has mentioned recently that the bank is very worried regarding the CPI inflation risks, whereas CBR Chairwoman Nabiullina said that the risks to inflation continue to be elevated. Meanwhile, the central bank in the January meeting stated that it cannot exclude the likelihood of tightening monetary policy if inflation risks increase with Yudayeva adding that tightening might include a key rate hike.

The headline CPI inflation might moderate further in March with the help of favorable base effects. However, it might accelerate later in 2016 due to ruble's depreciation. Overall, the central bank is expected to keep the interest rate on hold in 2016. However, in an alternative scenario, although with a lower possibility, the central bank might cut its key rate by up to 100bps in the second half of the year to support the economy.