The board of the Central Bank of Russia (CBR) at the final policy meeting of 2024 resolved to maintain the key interest rate at 21% percentage points, defying the expectations and despite stubborn inflation approaching double digits by the end of the year.

As followed by bne IntelliNews, the latest data points pointed to continuous acceleration of inflation ahead of the policy board meeting: with annual inflation coming at 9.5% as of December 16 and inflationary expectations of the population remaining high.

Towards the end of the year inflationary pressures intensified due to higher food prices ahead of holidays (chart), in addition to the most recent severe weakening in the ruble, and the seasonal hike in both state and household spending.

However, in a shock decision that defied market expectations, the CBR decided to maintain the key rate unchanged, opting to not increase the interest rates.

Policy pivot defying expectations

The CBR was expected by the analysts to hike the rate to 23%, with some believing that the regulator would opt for a bolder hike to 24%-25% to try to restore its grip on the market and inflation which continued to defy the guidance throughout the year.

But the CBR now sees the light in the end of the tunnel and commented that “given the significant increase in interest rates for final borrowers and the cooling of lending activity, the achieved tightness of monetary conditions forms the necessary preconditions for the resumption of the disinflation process and the return of inflation to the target, despite higher current price growth and strong domestic demand.” 

The CBR admits that “for some time, the current price growth will remain elevated due to the inertia caused by the accumulated effects of budget stimuli, high lending activity of the previous months and the transfer of the weakening of the ruble into prices”. 

Still, the regulator believes that in the coming months inflationary pressure will start to diminish under the influence of tight monetary conditions and slowdown in lending, while seeing the inflation returning to the elusive 4% target by 2026.

Renaissance Capital believes that keeping the key interest rate unchanged despite expectations indicates a change in the regulator's reaction function and a shift from a “complete and uncompromising” fight against inflation to a more balanced policy. 

The CBR could be embarking on a policy pivot, taking into account the costs of inflation targeting, including the burdens on the banking sector in terms of the realisation of credit risks. 

Positive signals from the crediting market 

Some recent data indeed showed that relief could be on its way for the CBR as corporate lending finally showed signs of slowdown in November. 

The CBR indeed seems to see positive inflationary signals in the crediting activity. In the statement accompanying the decision the regulator said that “monetary conditions have tightened more significantly than envisaged” following the 200bp hike in October and that “certain disinflation risks have increased” due to a slowdown in credit and lending activity. 

During the press conference, the Deputy Chairman of the CBR Alexey Zabotkin also mentioned that this time the CBR had more information than the market, due to feedback from companies and banks in the last few weeks.

Caving into pressure?

The decision to not hike the rate will inevitably put the independence of the CBR into question.  The regulator and its legendary governor Elvira Nabiullina finish the year under unprecedented pressure from businesses and authorities to address inflationary pressures differently than maintaining the key rate at over 20%, which is seen as choking the already disbalanced Russian real sector and public finances.

While President Vladimir Putin still seems to back the independence of the CBR and its Governor Elvira Nabiullina, unnamed sources told Bloomberg that even Prime Minister Mikhail Mishustin told Putin that the central bank’s actions were hampering the government’s efforts to support the sanctioned economy.

The CBR was seen as cornered and running out of options, as interest rates can only go so high without crushing the disbalanced Russian economy. 

“The unexpected decision by Russia’s central bank to leave interest rates on hold at 21.00% today, rather than hike further, sparks a lot of questions about the central bank’s reaction function – and whether it may be starting to become subject to political pressure,” Capital Economics wrote on December 20 on “a rare dovish surprise” from the CBR.

Although Capital Economics economists admit that “it’s not immediately obvious that the central bank’s decision today was driven by external pressure on policymakers,” they see it worth noting that criticism against aggressive monetary tightening has increased recently. 

Should CBR remain less responsive than in the past to the latest inflation developments, “this is clearly a risk that could end up entrenching high inflation,” Capital Economics argues.

Guidance for 2025

While the analysts now see the 21% key rate as a peak of the current monetary tightening cycle, the question now is whether the CBR will start to cut the rate quickly or will it keep it at 21% for a prolonged period of time.

RenCap analysts maintain the forecast that monetary policy easing will start in 2Q25 (base case - April), but change the key interest rate forecast for end-2025 from 17% to 16%.

“There are significant reasons to believe that the second stage of the monetary tightening cycle is complete. The CBR has also softened its signalling of future intentions, replacing the tougher promise of ‘allows for the possibility’ with ‘assess the feasibility’,” RenCap analysts comment. 

However, two past mottos of the CBR - “the rate cycle isn't over until it's over” and “there are usually no pauses in rate cycles” - now seem to be conflicting.

Still, Nabuillina left the door open for hiking the key rate at the next policy meeting in February.
“In February, we will choose between two possible solutions,” she said at the press-conference, as cited by RBC business portal. “Either we will make sure that the monetary tightness achieved is enough, or, if the current scale of demand overheating does not decrease and lending moves to a new round of expansion, we will return to discussing the issue of raising the key rate”. 

RenCap analysts estimate the probability of the last 1pp rate hike at the February meeting at 30%.  Capital Economic analysts expect the key interest rate to stay at 21%, although the risks could remain skewed to another hike in 1Q24 as inflation continues to rise.