Is Central Bank going to raise the rate in a fight with inflation and isn’t it late?

The Central Bank’s latest July key rate increase by a percentage point — up to 6,5% — has become the sharpest since December 2014. If annual inflation is considered to be at an officially declared level of 6,46%, we can say the real rate has reached a weak positive threshold. In another article for our newspaper, Realnoe Vremya’s columnist, economist with long-term banking experience Artur Safiulin reflects on whether Elvira Nabiullina’s institution is going to keep raising the key rate fighting inflation and if it isn’t late for such measures.

What Central Bank is saying

Together with the decision on raising the key rate, the outlook for annual inflation was corrected from 4,7-5,2% to 6,2% too. The CB thinks that they can return to 4-4,5% only in 2022. The average inflation level is assessed by the CB at 6-6,2% in 2021 and 4,1-4,9% in 2022.

Consequently, it is not ruled out that there will be at least one rise in the key rate.

Let’s see what’s happening to prices in Russia and why the CB has to balance the necessity of keeping the prices from growing and not going too far here by destroying the origins of economic growth. These oppositely directed processes require precise tuning too. We’d like to think that there will be struck a balance.

Reasons for inflation growth in Russia and the world

— the status of the issuer of the main accounting currency of the world obliges to take decisive actions to stimulate the economy, which was done — several trillion dollars were printed. As a result, a sharp increase in prices for everything — raw materials, food, and so on. In our early material, the mechanisms of these processes were described in detail.

In Russia, the first signs of an abnormal increase in inflation appeared at the end of 2020, when the devaluation of the ruble occurred, which added fuel to the fire. The impact of this factor is estimated at 1,5%. That is, if it were not for the fall in the ruble exchange rate, we would have had the opportunity to keep inflation at the level of 4% (as planned by the Central Bank). At the beginning of this year, prices were growing at such a pace that the state had to apply state control measures, which led to an even more rapid growth.

Measures taken and problems encountered

In March, the Central Bank had to take action and start raising the rate, at that time it was at the level of 4,25% — a historical minimum. It seemed that small increases could prevent the unfolding of inflationary spiral. But results are not yet visible — we are losing the battle with inflation. It should be remembered that the effect of changes in monetary policy occurs with a time delay. The increase in the key rate by 2,25% in 5 months is just beginning to have an impact on inflationary trends. We will feel the full-scale effect of the measures taken only in the fourth quarter of this year. As we noted in an earlier article, in addition to monetary policy, inflation is also affected by the conjuncture of commodity markets, which are now at their peak and where a correction is expected.

In general, many experts have doubts that it is possible to cope with inflation with the instruments of monetary policy alone. Based on the tone of the Central Bank's statements, the price increase is mainly due to stable factors — when demand outstrips supply. At the beginning of the year, the Central Bank believed inflation was accelerated by the growth of world prices for goods, this was seen as a temporary phenomenon. As an example, let's look at the market of vegetable products — over the past year, carrots and potatoes have more than doubled in price. Officials explain this by a poor harvest and talk about the need for imports, which is what is happening — in the first quarter of 2021, potato imports increased by 80%. Agricultural producers say that a deficit was expected, as they massively reduced planting areas and lived up to the need for imports.

Here an interesting point appears — the currency is required for the purchase of imports, but we are seeing an interesting discrepancy in the movement of exchange rates. In November 2020, oil fell below $40 per barrel, the ruble fell below 80 rubles per dollar. Today, oil is trading at a level above $75 per barrel, while the ruble remains at 75 rubles per dollar. It seems that the Central Bank deliberately keeps the ruble cheap — to help exporters and the budget (to increase revenues and reduce liabilities). The Central Bank is forced to buy foreign currency within the framework of the current budget rule in the current situation. Our international reserves are growing, and inflation is growing with them. With a lower dollar exchange rate, we, as consumers, would not pay so much for imports.

“A classic example of an ill-considered policy”

Another factor is the influence of monopolism on many markets. For example, since the beginning of the year, hotel services in Russia have risen in price by 25%, against the background of closed borders, hotels dictate their terms to customers. In June-July, prices for railway tickets increased by 20%. There is a problem of the balance of supply and demand, this is really a very serious factor in the inflationary spiral. Another striking example of this imbalance is the construction industry. During the lockdown, sales sank, and market participants asked the state for support. So there appeared a programme of preferential mortgages, which led to an increase in housing prices due to that demand, warmed up by loans, far exceeded supply. A classic example of ill-considered policy, populism in its essence. And the Central Bank has to sort out the effects of imbalance in the markets. As a measure to curb the growth rate of consumer lending, the Central Bank returned the risk coefficients on consumer loans for banks to pre-crisis levels.

In conclusion, I would like to note that the inflation expectations of the population, according to the Central Bank survey, are at a high level — 13,4%. The picture of inflationary risks remained unchanged, the Central Bank noted an improvement in the situation with food inflation and a weakening of inflationary pressure in general in June-July. Besides, the GDP growth forecast has increased from 3-4% to 4-4,5%, which is due not so much to an improvement in domestic demand expectations, but to external factors. It can be assumed that before the end of the year, the Central Bank will once again raise the key rate by 0,25-0,5 basis points. The tone of the Central Bank's comments indicates a limited potential for rate growth from the current level. It will be interesting to observe the result of the tightening of monetary policy as part of the fight against inflation, in which the Central Bank is fighting with many opponents, including, paradoxically, its own government.

Artur Safiulin

The author's opinion may not coincide with the position of the editorial board of Realnoe Vremya