‘By lifting the key rate the Central Bank thus is raising the value of money and holding inflation’

What happened?

At a recent board meeting, the Central Bank decided to keep the key rate at 7,5%. Many analysts considered such a result in the regulator's basic variant. Though the Central Bank notes a fall in the business activity in the country, it isn't yet ready to take further steps to soften its policy. This has to do with high inflation expectations of businesses and the population, which have even grown since the summer. Though the partial mobilisation is holding price growth, it cannot be an impulse response to spur inflation in the future.

Analysts think that in a positive variant the Central Bank could have reduced the key ratw by 25 or 50 bp, that's to say, to 7,25% or 7,5%. However, after the recent meeting and following press conference, the regulator indeed set course for stopping the reduction cycle. Chair of the Central Bank Elvira Nabiullina noted that an “upward and downward movement” was possible.

Vice Chair of the Bank of Russia Alexey Zabotin complemented her thought and directly claimed that the variant of lowering the key rate would not be considered at the recent meeting of the Board ot Directors thus year. It will be on 16 December.

“If we considered the possibility of lowering the key rate at the next meeting as significant, we would indicate it in a statement after the board meeting,” he claimed.

What awaits the Central Bank?

The mid-term outlook of the Central Bank that appeared after the meeting hasn't almost changed. Earlier, the Central Bank published its outlooks after a meeting on the key rate on 22 July when it decreased this figure gy 160 bp at once, to 8% a year.

So in the new mid-term outlook, the median key rate was fixed at 10,6%. In the footnotes the Central Bank wrote that this indicator was calculated given that the average rate from 31 October till the end of the year will be 7,4-7,6%.

This can indirectly mean that in the basic scenario at this year's final meeting of the Bank of Russia, there is going to be considered the issue of keeping the key rate at today's 7,5%. At the same time the existence or the diapason from 7,4 to 7,6% illustrates that the option of changing the key rate by 25 bp, that's to say, its fall to 7,25% or rise to 7,75%.

Inflation expectations changes too. If the price growth after the meeting on 22 July was forecasted at 12-15%, now the highest threshold fell to 13%.

“Annual inflation continues to gradually slow down. The annual growth rate of consumer prices decreased to 13,7% (after 14,4% in August), as of 21 October, it dropped to 12,0%,” reads the Central Bank's press release after the meeting on 28 October.

Moreover, in 2023 the Bank of Russia forecasts inflation to be 5-7% and by 2024 it can return to the target of 4%. However, the key rate is also predicted to go down in the next years. So according to the Central Bank's estimate, the average annual number can be 6,5%-8,5%, 6-7% in 2024, 5-6% in 2025.

These figures do not differ from the estimate on 22 July. The only exception is that the latest mid-term outlook has been added estimates for 2025.

Why does the Central Bank change the key rate?

“The change of the key rate is the basic option of regulation of the economy and inflation in the country,” analyst of Freedom Finance Global Vladimir Chernov and managing partner of GetMiner Ernest Rayevsky said in a talk with Realnoe Vremya.

“Inflation is growth of consumer prices for goods and services. A higher inflation rate means a higher cost or the same products with time. In otheh words, it is depreciation of money as much as the price for goods and services increased,”said Vladimir Chernov.

At the same time, Ernest Rayevsky notes that the key rate is the interest the Central Bank grants loan at to commercial banks and accepts deposits from them. And amid inflation growth the rise in this indicator helps to raise the value of money and scotch inflation.

“By lifting the interest rate the Central Bank thus is raising the value of money and holding inflation: loan rates are going up and companies are taking out fewer loans, spending less on purchases. This holds the growth of prices for goods and services and slows down inflation,” he said.

Moreover, the reduction of the key rate causes a fall in loan rates, which makes them more attractive. This is why the population starts to have artificially more available money and their purchasing power grows. So people start to buy more goods and services because of which prices for them begin to rise, that's to say, inflation grows.

Also, Ernest Rayevsky notes that lowering the key rate helps to revive businesses during a crisis.

How can one earn on the growth of the key rate?

Besides slower inflation, a higher key rate raises deposit rates. Thus, people are called upon to save more than spend. When the national currency cheapens, income from bank deposits help to save one's purchasing power fully or partly: this income will compensate for the price growth.

“Deposit rates go up after the refinancing rate is raised because the yield of Federal Loan Bonds commercial banks buy to augment the profitability,” explains Vladimir Chernov.

So, for instance, on 18 March when the key rate was 20%, the Bank of Russia claimed that the average deposit rates in the country's 10 largest banks rose to 20,51%. This helped to save people's financial situation amid economic turmoil and fast growing inflation. A day earlier it became known that the demand for deposits from Russians soared by 369%.

Nevertheless, deposit profit at Ak Bars Bank in early March increased by 22%, at Zenit it did to 22,5% for premium deposits.

Analyst of Tinkoff Investments Mikhail Ivanov notes that besides deposits investors can have a closer look at Federal Loan Bonds with a flexible rate. Coupons of such bonds are tied to the RUONIA rate, which is close to the key rate. According to his estimate, this allows receiving good income when the Bank of Russia tightens its policy.

Artyom Gafarov