Central Bank offers to cancel preferential state programmes and mortgage

Elvira Nabiullina pinned a hawk brooch

Today the Bank of Russia unexpectedly announced on 20 March that it was raising the key rate by 0,25 of percentage points to 4,5% a year. The monetary policy is tightening for the first time since December 2018. Amid the pandemic in 2020, the regulator lowered the rate from 6,25 to 4,25%. The Central Bank made a decision to increase the key rate for the first time in two years after surviving the economy’s decline due to COVID-19 restrictions trying to influence the suddenly hiked inflation in Russia. Consumer prices in the first quarter turned out to be above the regulator’s forecasts, and the balance of risks shifted to pro-inflation risks. The Central Bank said the necessity to go back to a neutral monetary policy was dictated because demand was recovering fast, while inflation pressure was growing. Also, the regulator didn’t exclude that it would be decided to keep raising the key rate at the next meetings.

“In the sentence ‘save not raise’, we put the comma in the right place,” claimed Nabiullina at a press conference on 19 March.

And her jacket was adorned with a big hawk brooch with stretched wings. It has been known for long that the head of the Russian Central Bank chooses brooches for press conferences depending on the key message she wants to communicate to the audience. We should remind you that when the Central Bank stopped the fall in the rate in February, Nabiullina wore a laconic brooch in the form of a dot.

Why Central Banks makes a U-turn

It should be reminded why the decision was a surprise. The case is that head of the Russian regulator Elvira Nabiullina promised as early as late last year that the monetary policy would be soft (not neutral, not to mention more severe). The Bank of Russia claimed that interest rates would remain low until the economy recovers and was sure that this recovery “wouldn’t be rapid”.

“We expect the economic growth in Russia at 3-4% next year, 2,5-3,5% in 2022 and 2-3% in 2023. In other words, the economy will reach the pre-crisis level in the middle of 2022,” Chairwoman of the Central Bank Elvira Nabiullin said in November 2020 when presenting key areas of the monetary policy in the next years in the State Duma.

Still, she left some room for manoeuvre for herself and specified that the Bank of Russia would support interest rates and the Central Bank’s monetary policy in 2021 would be soft if only the disinflationary influence of the pandemic “stays or gets stronger”. The low price of money was to increase the availability of loans, thus demand (both consumer and investment demand). This, in turn, was to accelerate the return of the Russian economy to life and stabilise inflation at 4%.

However, in early 2021, the growth of consumer prices began to concern the Russian authorities. Both the government and Putin personally claimed this wasn’t allowed at different times. As a consequence, experts immediately began to warn that the Bank of Russia wouldn’t lower the rate once again.

What the regulator itself did last month was to save the key rate at the previous level but increased the outlook on inflation in 2021 — from 3,5-4% to 3,7-4,2%. Chairwoman of the Bank of Russia Elvira Nabiullina announced at the same time that the rate’s reduction cycle was over — the pigeon rhetoric ended. The CB targets inflation at around 4%. But the rise in prices in Russia has lately speeded up: in January, it exceeded 5% year on year, in February, it reached 5,7%, which became the maximum since February 2016.

And only Sberbank wasn’t surprised

Most economists waited for the 4,25% rate to stay. Sberbank analysts who just recently said that the CB would anyway start the flight of the hawk and raise the key rate turned out to be a step ahead. Gref’s subordinates noted that both the hike in market rates in developed countries (for instance, in American treasury bonds) and the rise in inflation risks in the world and Russia can help the key rate to go up.

Sberbank even managed to hear “signals of the beginning of a cycle of a stricter monetary policy” in the regulator’s statements (though this hasn’t yet happened, it was soft and became neutral). At the same time, the Sberbank analysts considered that the rise in the rates “won’t have a significant impact on the economic activity while the growth of the Russian and world economies is recovering”.

Some foreign experts — an extinct minority — assume that the Russian regulator could raise the rate even by 1,25 pp by late 2021 — to 5,5 and even 6%. Bloomberg analysts explained such forecasts by the fact of the same higher inflation and fears about the growth of budget expenses. At the traditional press conference on 19 March, Elvira Nabiullina claimed the Russian economy was recovering more confidently than expected. And the CB is waiting for its further growth. This is why they are going back to the neutral monetary policy to return inflation to 4,2%. However, the Bank of Russia expects this only in the first half of 2022. By the regulator’s estimates, inflation will top 4% by late 2021.

Two lures for hawks

Nabiullina explained what influenced the decision of the Russian Central Bank’s functionaries.

Firstly, stable components of annual inflation turned out to be above 4%, which indicated higher inflation pressure in a wide range of commodities. Moreover, supply in the Russian market can’t yet outstrip the explosive growth of demand.

“Demand was disinflationary demand in 2020, now it became pro-inflationary. The epidemiological situation is improving, the restrictions are lifted, people are making purchases that postponed: they are buying household appliances, goods for home repairs, spending money on entertainment and trips. Demand is confidently recovering, while supply takes more time to recover. It is not easy to restore the chain of supplies, enterprises need time to adapt to increased demand for goods. The sector of domestic tourism is a good example: everything happened quickly and unexpectedly, tourism infrastructure wasn’t ready,” Nabiullina explained.

According to her, Russians’ pent-up demand for flights abroad in 2020 totalled 2 trillion rubles a year. Some of this money that wasn’t spent abroad became a saving, people spent some part of it on domestic tourism or bought a commodity that would be used for long. In other words, the quarantine and pandemic backed domestic demand.

Price growth for foodstuffs has accelerated now, moreover, the Russian government’s measures taken to restrict it enabled to only smooth some rise. And then an ordinary spiral was launched: the growth of prices for basic goods in itself led to a rise in Russians’ inflation expectations. Russians’ inflation expectations are already above the pre-pandemic bar. The rate had to be raised to prevent inflation from exacerbating.

Secondly, the Russian economy is growing faster and more stable than the expectations thanks to that demand, moreover, both domestic and foreign demand. Nabiullina says that exports of metals, chemicals, foodstuffs are growing in front of their eyes. The Bank of Russia has registered growth of business activity and employment in the domestic market. Consumer demand for durable goods has gone up, demand for cars is still high.

“Production is many sectors has already resumed, for instance, the production of furniture, household appliances, clothes, fertilisers, agricultural machinery. We also register a resumption of production in more affected sectors — the business activity is augmenting in the services sphere. We expect the economy keep growing thanks to vaccination and preferential state programmes,” Elvira Nabiullina claimed optimistically. “The economy will bounce back to the pre-crisis level until late 2021.”

“Preferential state programmes have to complete”

The key rate will go on rising unless it reaches the neutral diapason, that’s to say, 5-6%. The CB considers the terms of the monetary policy to be soft, though the head of the Bank of Russia says the level of lending is already close to the record high in the last years.

“This happens thanks to preferential loans granted for governmental programmes, which allows additionally softening the monetary policy. The CB has to save stricter terms for everybody. Preferential state programmes have to complete after the economy’s decline end, after the peak of the crisis. In the future, such state programmes should be short-term and targeted. Otherwise, the budget and economy will pay for them due to high rates,” Nabiullina made a signal to the Russian government.

At the same time, Nabiullina warned that inflation risks still remain, but a soft monetary policy of developed countries can influence them (when it will bring to a faster recovery of the world economy). Demand for Russian export increasing the influence of domestic demand can stir up inflation too. If prices in the world’s commodity markets start growing, this can happen in the Russian domestic market too (however, we already see it today in foodstuffs). Nabiullina sees separate risks of inflation growth in supply, that’s to say, businesses and the industry, particularly due to production costs and a lack of staff.

Also, the head of the Bank of Russia commented on the regulator’s opinion about the closure of large-scale preferential mortgage programmes in some Russian regions. It is offered to leave the programmes only in some regions, and only till the end of the year. Moreover, it can’t be a region where the preferential mortgage hasn’t raised prices for housing and created prerequisites for a “mortgage bubble”.

“The growth pace of housing prices in regions is the most important thing as well as the room of the housing supply. If a preferential mortgage turns into a rise in prices, housing becomes more accessible for people. Prices in Russia’s market of new homes increased by 12% last year, it is above inflation. But even after large-scale anti-crisis programmes end, permanent targeted programmes should stay, designed for only some people, regions, cities where constructors aren’t interesting in developing housing.”

In addition, one can’t hold prices artificially and support the ruble

Elvira Nabiullina commented on a proposal of the authors of administrative price regulation. Constant price monitoring itself is crucial, she agreed. But every agency can offer measures of administrative and economic regulation after its price monitoring:

“But if sudden measures of economic price regulation that will influence companies’ business projects are taken, this will be a factor of uncertainty. A factor of unpredictability is needed. It is critical for a business,” she claimed. “As for the ban on raising prices for socially important goods... I think that administrative bans are an extreme measure, and they can work only short-term. Consequently, this can have only a short-term effect. If the measures prohibiting increasing prices are taken for long, they will lead to negative consequences and growth of inflation pressure.”

As for the ruble rate, the CB thinks that its volatility influences inflation less than several years ago. The weakening of the ruble rate by 10% brings only to a rise in annual inflation by 0,5-0,6%. Earlier, such an increase would be twice bigger.

The weakening of the ruble rate itself in 2020 brought to the growth of inflation, but this effect is already considered in prices at this moment. Artificial measures of support for the ruble rate will reduce inflation short-term, but in the long term, they can weaken the rate and put pressure on inflation, Nabiullina warned.