Consumer prices have been surging in the last few months as Russia’s economic recovery gets under way and the slump in the ruble’s value from last year works its way through the system. The Central Bank of Russia (CBR) has already signalled that a two-year-long easing cycle has come to an end, but the market is watching closely to see if it will hike rates at the March 19 monetary policy meeting.

On balance few economists except the regulator to pull the trigger this week, as it is still in wait-and-see mode, but they anticipate strong tightening language going forward and possibly at least one hike in the first half of this year, and possibly as soon as April if inflationary pressures cannot be tamed.

“A series of strong inflation readings in Russia have put the central bank’s ability to meet its inflation target over the next year under threat and brought forward the prospect of monetary tightening. We think the central bank will use its meeting on March 19 to lay the groundwork for an interest rate hike in April,” Liam Peach, chief economist with Capital Economics, said in a note on March 10.

An economic rebound after the 2020 annus horribilis is more than welcome, but it comes with its own set of new problems. Inflation readings in Russia have gone from bad to worse and prices  soared in February to a four-year high of 5.7% year on year.

The rise in prices has surprised no one, due to the low base effect and the pass-through effects following the slump in the ruble after oil prices collapsed last year. But the growth in prices has been much stronger than expected, as there has been an acceleration in the pace of monthly price growth since October, says Peach.

“In seasonally adjusted month-on-month terms, inflation rose from 0.4% in Q3 to 0.6% in Q4, and to 0.7% in February. To put this into perspective, the rate of inflation consistent with the 4% target is 0.3% m/m; since October, price growth has been consistent with annualised inflation of 7% y/y,” Peach reports.

Sugar prices spike

Rapidly rising food prices have done the most damage, leading Russian President Vladimir Putin to use a large part of his annual press conference earlier this year to talk about the cost of pasta.

Food inflation hit a five-year high of 7.7% y/y last month and the CBR estimated that sugar and sunflower oil accounted for two-thirds of the rise between October and December, largely due to poor harvests. Sugar prices alone rose by 75% y/y in that period.

Since then, the government has imposed price caps on sugar and cooking oil, which has halted the rise in those prices, but the increases in food inflation have now become broad-based, with sharp price jumps in meat, fruit and vegetables.

And the surge in food inflation shows no signs of letting up, reports Capital Economics. The prices of eggs and beef are rising sharply and producer prices of grains have surged.

“The S&P GSCI Agricultural and Livestock Index rose by 50% y/y in ruble terms in February and, even if prices stabilise from here, food inflation won’t begin to ease materially until late-Q3. We think food inflation will reach 8.0% y/y in March and ease slowly thereafter,” says Peach.

The question is how long this surge will last. Normally food prices fall in the summer as the harvests begin to come in and most Russians move to the dacha and grow their own food: last year two thirds of Russia’s potato crop was grown on private plots at dachas across the country.

Moreover, the outlook for this year’s harvest is good, with the Agriculture Ministry predicting a grain crop of 131mn tonnes, only slightly down from last year’s 133mn tonnes, itself the second-best harvest of all time. If the harvest is as good as anticipated, then inflationary pressure should abate rapidly from the end of the second quarter.  

Non-food prices also on the rise

While food inflation pressures should start to ease as the weather warms, the problem is inflationary pressures are spilling over into non-food items in recent months, which is much more persistent.

“The pass-through from the ruble, a recovery in demand for household goods and supply constraints in sectors such as motor vehicles have pushed up prices,” says Peach.

The CBR acknowledged these pressures in February, but the extent of the rise in inflation will have become a bigger concern since then. Manufacturing producer prices and freight costs have surged this year and the input prices balance of the PMIs remain high.

Many analysts expect that February's increase in inflation to 5.7% will be the peak for this year, but Capital Economics predicts there is more to come, with inflation rising to a peak in March of 5.8-5.9% y/y.

“It should then begin to drop back due to base effects, easing supply issues in the agricultural sector and disinflation from the stabilisation of the ruble,” says Peach. “But inflation will probably fall much more slowly than we had previously expected, easing to 4.3% y/y by year-end (CBR: 3.7-4.2%) and bottoming out at 4% in early 2022.”

The CBR is watching closely. CBR Governor Elvira Nabiullina has clearly signalled that there will be no more rate cuts for the meantime. (She wore a “full-stop” broach to the last meeting in February.) But given that inflation is widely predicted to start falling from the second quarter onwards, few expect the CBR to reverse two years of easing; the last time the CBR hiked rates was in December 2018 and it has been cutting rates aggressively since the emergency 17% rate hike at the end of 2014 during an oil price shock crisis.

The CBR will want to throw some cold water on price appreciation at the March 19 meeting, as the inflationary pressures are now too strong to ignore; a small hike now is possible which will be less painful than bigger and more durable hikes later.

Certainly the Russian people think prices are going to continue to go up. Household inflation expectations are high and have been for a while. The CBR is worried that if price rises are too strong then this will un-anchor these expectations and rising prices will become a self-fulfilling prophesy.

“If the CBR assesses that the strength of inflation will be maintained and that there is a risk of inflation remaining above the 4% target, we think it will tighten policy,” says Peach. “We doubt the CBR will hike interest rates at its meeting on 19th March, but it will probably send a strong signal for a 25bp rate hike in April.”