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Sep 19, 2022
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Unique deflation helps Russia

The Central Bank continues to act in the interests of the real economy and has lowered the rate for the sixth time this year. Now it is 7.5%, and economists expect 7% by the end of the year. The regulator’s boldness is fueled by the unique deflation that continues to persist in Russia. The Central Bank even improved its inflation forecast by the end of the year. Russia managed to contain the rise in prices and reduce the cost of loans under unprecedented sanctions pressure.

The Central Bank, headed by Elvira Nabiullina, cut the rate by 0.5% for the sixth time this year, from 8% to 7.5%. This is in line with the forecasts of most economists. The central bank cuts rates so boldly because deflation persists in Russia. Moreover, the regulator even improved its inflation forecast by the end of the year. Now the department expects that it will not exceed 11-13%, while earlier it was about 12-15%.

“The most significant contribution to deflation is made by fruit and vegetable products, in second place are passenger air transportation. At the same time, growth in most other goods and services is minimal, which allows the dynamics of fruit and vegetable products to have a stronger influence on the overall inflation rate,” explains Vladimir Evstifeev, head of the analytical department of Zenit Bank.

Decrease in prices for cucumbers, tomatoes and other vegetables in summer is quite a seasonal phenomenon. Although this does not always mean deflation. But the closer autumn is, the less vegetables from the open ground and their stocks, and the more vegetables from greenhouses become, which means that vegetables will gradually begin to rise in price. Weekly deflation from September 6 to 12 has already slowed significantly compared to last week (0.03% vs. 0.13%), according to Rosstat. Prices went up mainly only for cucumbers, while prices for tomatoes remained almost unchanged, while prices for potatoes, cabbage, onions, beets and carrots fell.

According to Zenith Bank’s expectations, the deflationary trend will end in October-November. However, the chances are high that annual inflation will be within 11-13%, as expected by the Central Bank of the Russian Federation. “Consumer activity is slowing down, which will not allow manufacturers to fully shift the growing costs into prices,” Evstifeev believes.

Although inflation in 2022 will be in the double digits, it can be called an extremely successful indicator, since it is worth considering the context and the strongest sanctions pressure.

“If inflation at the end of 2022 reaches the level of 11-13%, as predicted by the Central Bank of the Russian Federation, this will be a good result. The highest level of annual inflation in Russia in the 21st century was 13%, inflation reached this mark in 2015 during the almost forgotten global economic crisis of 2014-2016. Then the sanctions were much softer than today, foreign companies did not refuse to supply their goods to Russia.

So this success can be considered the result of both a well-thought-out monetary policy of the Bank of Russia and competent actions of the Russian government, including the Ministry of Finance, the Federal Tax Service, and the Ministry of Industry and Trade,” says Natalia Milchakova, Lead Analyst at Freedom Finance Global.

“Earlier, during periods of crisis, acceleration of inflation was an integral part, since there was pressure on the ruble due to the outflow of private foreign capital, which led to an increase in the cost of imports and the cost of living in general. Later, local players also joined the process of ruble devaluation. This time, the authorities managed to bring down the panic and prevent the uncontrolled growth of inflation. Mainly due to the introduction of capital controls, restrictions on cash and the closure of trading on the stock exchange in the most critical periods,” notes Evstifeev.

Already in the next 2023, economists expect inflation to be significantly lower than this year. “First of all, because inflationary expectations of the population will decrease, and producers and sellers, due to a strong decline in retail sales, will have an incentive to restrain price increases in order to avoid a drop in demand and an overproduction crisis. According to our forecast, annual consumer price inflation in 2023 will decrease to 5-8%,” says Milchakova.

An unexpected signal from the Central Bank on Friday was the fact that the regulator’s message did not include the traditional phrase that it would continue to allow the rate to be changed depending on the expediency of 50 to 50. That is, for the first time there was no signal that the rate would continue to decrease. Some saw the cycle of rate cuts as complete. However, not everything is so clear.

“Despite the fact that the Central Bank of the Russian Federation warned that the period of a sharp reduction in the key rate is close to an end, this does not yet mean that the regulator will stop, starting from the next meeting of the board of directors, to cut the rate altogether this year. Rather, we were warned that there would be no sharp cuts in the key rate this year,” says Natalya Milchakova. In her opinion, before the end of the year, the Central Bank will cut the rate one or two more times at two meetings scheduled before the end of the year, so that by the end of 2022 it will drop to 7%. The key rate has already become lower than it was in December 2021 (8.5%). But the return of the key rate to its historical minimum of 4.25% is still far away. “The return of the rate to a historical minimum, or at least to a level below 5% per annum, is most likely when the level of consumer price inflation in Russia does not exceed 4% per year, that is, according to our forecast, not earlier than 2024,” says Milchakova.

Nevertheless, consumer and other loans are already becoming cheaper following the rate cut by the Central Bank. The key rate is an indicator according to which the Central Bank lends to banks. The lower it is, the cheaper loans banks can offer households and businesses – as a rule, this is a key rate plus 3-4%.

“The Bank of Russia may reduce the key rate to 7% this year, which will help make credit funds more accessible to businesses, which will ultimately help maintain and increase the number of jobs. In addition, interest rates on loans provided to the population, including mortgages, will be slightly reduced,” says Alexander Abramov, head of the laboratory for the analysis of institutions and financial markets at the Institute for Applied Economic Research of the RANEPA.

Some banks quickly responded to the actions of the regulator. So, Sberbank announced that from September 19 it will reduce the minimum down payment on a secondary mortgage from 15 to 10%. The terms will apply to all customers. Alfa-Bank announced a reduction in interest on loans for any purpose. Now it will be possible to take a cash loan at a rate of 4.5%, and a loan secured by real estate – from 4%. The average mortgage rate for the first decade of December in the top 20 banks was 10-10.5%. By the end of the year, this indicator can be expected to decrease by another 0.5% or even by 1% by the end of the year (if there is a decrease to 7%). However, banks will decline slowly, over several weeks.

But the rates on bank deposits and savings accounts, on the contrary, will decrease. This will make passive accumulation less profitable and force Russians to look for other objects of savings investment, Abramov notes.

“Average rates on deposits stopped at the level of 6.59-6.93% per annum. If the regulator gives a signal that it is ready to cut the rate further until the end of the year, then the deposit rate curve may slightly decrease,” said Igor Alutin, Managing Director of the Finuslugi project of the Moscow Exchange.

In his opinion, taking into account the forecasts of the Central Bank for the key rate and inflation, it is better to place free funds for a longer period – to open deposits from six months or more. Because if you place funds for 90 days, and then transfer the money to a new deposit, then the rate is likely to be lower.

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