The board of the Central Bank of Russia (CBR) at the policy meeting on July 21 has raised the key interest rate by 100 basis points from 7.5% to 8.5% per annum, the regulator said in a statement. Prior to that, the rate had remained unchanged since September 2022. (chart)

Although a rate hike was expected by the market, the CBR made an aggressive and front-loaded hike of 100bp, double the consensus expectations of 50bp increase.

The CBR recognised the recent weakening of the ruble as posing “significantly increased” inflation risks and even slightly worsened the 2023 inflation forecast to 5-6.5% from the previous guidance of 4.5-6.5%.

"The current rate of price growth, including a broad set of sustainable indicators, has exceeded 4% year on year and continues to rise. The increase in domestic demand exceeds the capacity to expand production, including due to limited available labour resources. This increases sustainable inflationary pressure in the economy," the CBR commented. 

As of July 17, annual inflation rose to 3.6% after 2.5% in May and 3.3% in June, the CBR said. The figure is still below the target of 4%, but it has repeatedly emphasised that this is due to the high base of last year, when prices jumped due to the fallout of Russia’s full-scale military invasion of Ukraine.

The CBR also expectedly reminded that “domestic demand exceeds the capacity to expand production in many sectors, including due to limited free labour resources." The regulator also noted that in July inflation expectations of the population worsened from 10.2 to 11.1%

The analysts surveyed by RBC business portal see CBR as determined to rein in inflation to the 4% target, and remind that key interest rate decisions affect inflation with a lag of three to six quarters.

However, as the policy meeting was expected to see the start of the new monetary tightening cycle, a front-loaded rate hike to 8.5% will likely see the outlook on key interest rate in 2023 adjust upwards to 9.5% and even 10%.

The analysts surveyed by RBC believe that the CBR could hike the interest rate again in September-October policy meetings by 50bp-75bp.

The CBR indeed stressed that it "admits the possibility of a further increase in the key rate at the next meetings to stabilise inflation near 4% in 2024 and beyond". At the same time, the regulator believes that "the recovery phase of the Russian economy development is generally completed" and "in the future, economic growth rates will gradually approach the rates corresponding to the trajectory of balanced growth".

As expected, the CBR also warned the government against the temptation to boost spending, noting that in case of additional expansion of the budget deficit, pro-inflationary risks will become even stronger – and then additional tightening of monetary policy will be required.

The CBR forecasts GDP growth of 1.5-2.5% in 2023, 0.5-2.5% in 2024, 1-2% in 2025 and 1.5-2.5% in 2026. The regulator previously expected growth of 0.5-2% in 2023, 0.5-2.5% in 2024 and 1.5-2.5% in 2025.