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Central Bank of Russia: we are approaching the “fine-tuning” mode

Our comment

On Friday, June 10, the regular scheduled meeting of the Bank of Russia on monetary policy (MP) took place, during which the key rate was lowered again. This time the regulator’s ‘step’ turned out to be more conservative and amounted to 150 bp, thus the cost of lending fell to 9.5% (that is, to the value that preceded the start of the ‘special operation’ and the imposition of sanctions). However, it outperformed the experts’ consensus (-100 bp, up 10%).

The steeper downward trajectory of the benchmark was justified by a strong slowdown in inflation and a smaller-than-originally expected decline in economic activity. For the last three weeks, Rosstat has recorded zero or negative weekly growth in consumer prices. Thus, the annual inflation rate decreased to 17% by the beginning of June (compared to 17.83% in April). At the same time, pro-inflationary risks remain significant and may further increase due to unanchored inflation expectations.

During the meeting, the Board of Directors of the Central Bank considered two main scenarios: lowering the rate to 10% and 9.5%, eventually settling on a wider step. This decision also coincided with our expectations.

At the same time, the regulator revised its inflation forecast for the current year, which is now expected to be 14-17% instead of the previous 18-23%. The average forecast value of the key rate in 2022 has been reduced to 10.8-11.4%. This implies that in the remaining six months of the year it will average between 9.5% and 8.5%. Thus, in the conservative scenario, the cost of lending may remain unchanged until the end of the year, while the optimistic forecast suggests a decline of up to 7.5%. According to our updated baseline forecast, the CBR will continue to act more conservatively, moving into a ‘fine-tuning’ mode to reduce the key rate to 8-8.5% by the end of the year.

Market reaction

Local government bonds have been actively rising in price lately amid expectations of a sharper than originally expected reduction in the key rate, supported by the ‘soft’ rhetoric of representatives of the Central Bank. On the eve of the announcement of the decision, the yield of almost the entire OFZ curve was below 9%. At the same time, despite the fact that the regulator’s step became even wider than most investors expected, the ‘tougher’ rhetoric interrupted the uptrend. After the press conference of the head of the Central Bank ended, long and medium-term issues lost all the profit accumulated since the opening of the trading session.

However, in our opinion, the observed correction will not be protracted. Provided that the trend of decelerating annual inflation continues, narrowing the gap with the lower limit of the Bank of Russia’s forecast range faster, the probability of realizing the ‘optimistic’ forecast of the key rate dynamics by the end of the year will increase. Thus, OFZ prices still have upside potential in the short term. According to our forecasts, in the next few months, the positive revaluation of long bonds with a constant coupon may be at least 4-5%.

Highlights of the press conference

  • A change in legislation regarding ‘replacement’ bonds will be announced shortly. Russian issuers will be able to place a new type of instrument to replace outstanding Eurobonds and replenish the rights of local investors who cannot receive payments due to the non-functioning Euroclear-NSD bridge. It is assumed that the size, redemption date, as well as the nominal value of Russian bonds will correspond to similar conditions for Eurobonds.
  • Preparations are underway for possible legal steps in connection with challenging the sanctions against NSD.
  • A decision on restrictions related to cash withdrawals by individuals may be announced in early September.
  • The consequences of the sanctions are not yet as clear as initially expected, but it is still premature to say that their negative potential has been exhausted.
  • Fiscal policy becomes stimulating. However, its additional ‘easing’ could have an excessive pro-inflationary effect on the economy. Getting inflation back on target in 2024 may require tighter monetary policy than currently envisaged.
  • The low rate of inflation in recent weeks cannot be considered sustainable. For the bulk of positions, the price growth rate is still much higher than the target 4%.
  • The Bank of Russia does not include the risk of stagflation in its baseline forecast.
  • Forced conversion of individuals’ foreign currency accounts into ruble ones is not planned.
  • It is premature to talk about standard steps in the monetary policy due to the high uncertainty of the situation. However, when the key rate moves to single digits, the size of the step will be determined more “subtly” the situation is too uncertain, said Elvira Nabiullina, head of the Bank of Russia.

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