Inflation fell to below the Central Bank of Russia's (CBR) target level of 4% in July the lowest level since the bank switched to inflation targeting policy in late 2014 and lowest level since May 2012.

Russia's inflation slowed to 3.9% in year-on-year terms and 0.1% in month-on-month terms in July, Rosstat statistics agency said on August 6. 

The preliminary July inflation figures (more detailed figures are due this week) showing deflation during the last week of July is positive and that the period of accelerating inflation turned out to be short-lived, as government officials had mentioned earlier. Should the seasonal deflation trend continue in August, it cannot be ruled out that annual inflation will return to the CBR’s target of 4.0% y/y.

Monthly deflation has been registered only three times in Russia over the past 15 years, and in all these three cases it occurred in August (in 2003, 2005 and 2011). Deflation then ranged between 0.1-0.4% M/m.

Improvement of the short-term inflationary trend coupled with the CBR’s recent decision to issue 3M coupon bonds (COBRs), which could lead to a moderate increase in short-term market rates under the current level of the central bank’s key rate could allow the regulator to cut its key rate at the next meeting in mid-September.

After delivering a negative surprise in June, in July the regulator paused the monetary easing cycle due to a spike in inflation and external instability.

Alfa Bank commented on July 8 that inflation readings for July were "surprisingly low", with deflation previously expected to occur no sooner than August-September. 

"Considering that inflation had reached 0.4% MTD [month-to-date], as of 10 July, the deceleration in the inflation rate for the month to 0.1% m/m suggests that deflationary pressure is very strong," Alfa estimates.

Alfa also expects the CBR to be less concerned now about the pass-through effect from the weaker ruble exchange rate and sees an increasing likelihood of the CBR cutting its policy rate by 50 bps by to 8.5% at the next policy meeting on September 15.

"The decline of inflation in July below the CBR’s target shows that the central bank might have an opportunity to cut the key rate by 25-50bp at the next meeting," Gazprombank also wrote on July 7, arguing that the scale of the cut will also depend on whether monthly deflation occurs in August. 

However, both Gazprombank and Alfa Bank remind that the central bank held the interest rate unchanged at the last meeting in July due to households’ long-term inflation and the worsened geopolitical backdrop, which remain as factors to be taken into account. 

VTB Bank on August 7 questioned the reliability of weekly inflation reports provided by RosStat, as those led to misguided estimates of July's full-month figures (with all the analysts and the Bloomberg-compiled consensus missing the forecast).

"One cannot help but wonder if it was also a surprise to the CBR’s Board of Directors, which noted food prices as a risk to the inflation forecast when earlier deciding to keep the key rate on hold," VTB comments.

High discrepancy between the expectations based on weekly Rosstat data and the monthly results already occurred in April and are a reminder of how the agency came under fire earlier this year over the accuracy of its data.