Second Inflation Shocker Is Unlikely to Change the Bank of Russia's Long-Term Plans

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Delivering yet another jolt to Russia’s central bank, last month brought a new surprise after an inflationary shock in June.

The unexpected reading in the consumer-price index pushed it below the Bank of Russia’s target of 4 percent months ahead of a year-end deadline, as a surge in food costs fizzled out. But when it comes to the direction of policy, the turnaround may not be much of a game changer after the central bank put its easing cycle on pause in July following three straight cuts. The ruble ended Friday up 0.7 percent against the dollar, its biggest gain in more than a week.

“There are many other factors the central bank is looking at beyond the inflation print,” said Kiran Kowshik, a strategist at UniCredit SpA in London. “I don’t think this changes anything.”

Offsetting the price slowdown is the jump in inflation expectations, which the central bank calls a “pillar” of its rate decisions. Policy makers must also contend with U.S. sanctions and the danger they present to the ruble. “Exchange-rate dynamics amid elevated geopolitical risks” were listed among the biggest inflation threats in the central bank’s statement after a meeting on July 28.

“From the central bank’s point of view, the upsurge in people’s inflation expectations in June and July is more important than actual data on inflation,” said Dmitry Shagardin, chief economist at Bank Saint-Petersburg PJSC.

Still, monetary easing remains a question of when, not if, especially after consumer prices only increased an annual 3.9 percent last month, the least since 2012. The Bank of Russia said after a meeting in July that there was “room” for decreases in the second half of the year. Policy makers may feel confident enough to cut the benchmark by half a percentage point in September, according to Alfa Bank, ING Groep NV and Bank Saint-Petersburg.

Bond Rally

The inflation surprise also gave a boost to investor sentiment that has been battered in the past two months by the U.S. move to codify tougher sanctions against Russia. 

The government’s 10-year bonds were the best performers in emerging markets on Friday, with the yield dropping seven basis points to 7.72 percent, the lowest in a month. They held near that level on Monday, trading little changed. The ruble traded 0.2 percent weaker against the dollar in Moscow, paring a two-day advance.

But with presidential elections less than a year away, authorities are on alert as inflation remains a top concern for Russians. Growing prices and depreciation of savings led the ranking of “fears” in a poll by the Russian Public Opinion Research Center in June. That’s the top worry, ahead of international tensions, health problems and crime. 

A survey conducted on behalf of the central bank showed that 46 percent of respondents in July didn’t believe inflation will end the year at 4 percent.

It may take another 15 years for people’s savings behavior to change, according to ACRA, a Russian ratings company. That’s the period of time needed for individuals traumatized by hyperinflation, a debt default and the banking crises of the 1990s to get past the working age, said Natalia Porokhova, head of ACRA’s research and forecasting group.

“Inflation expectations are holding at a very high level,” which “limits the central bank in cutting the key rate,” she said. “Psychological factors are very inertia-bound.”

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