Russia Surprises With Bigger Rate Cut and Warns on Downturn

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Russia's central bank cut interest rates more than forecast and indicated that borrowing costs may fall even lower, as priorities shift to supporting an economy derailed by international sanctions over the invasion of Ukraine.

Three weeks after reversing part of the emergency hike delivered after the attack, the Bank of Russia again lowered its benchmark by three percentage points to 14%. All economists surveyed by Bloomberg predicted smaller decreases.

At a news conference following the decision, Governor Elvira Nabiullina took questions for the first time since the war began in late February. The central bank sees room to cut rates further this year -- probably at a more gradual pace -- depending on the balance of risks and the performance of the economy relative to forecasts, according to Nabiullina.

“We are in a zone of colossal uncertainty,” said Nabiullina, who gave her first rates press conference without a brooch. Before the war, she'd used the item of jewelry to send sometimes-whimsical hints about the direction of policy.

“We will make decisions on monetary policy taking into account the need to adapt the economy to a radically changing environment,” Nabiullina said. “At the same time, price stability remains our unconditional priority, since sustainable economic growth is impossible without it.”

As the world's most-sanctioned nation braces for a deep recession, the Bank of Russia is seizing on a moment when inflation is starting to stabilize and the ruble, sheltered by capital controls, more than recoups losses it suffered after the war.

The central bank said in a statement on Friday that a stronger currency, alongside weak consumer activity, helped put the brakes on prices. It also warned the economy may face two straight years of contraction.

“The ruble's exchange rate dynamics will remain a meaningful factor shaping the path of inflation and inflation expectations,” the bank said. “The external environment for the Russian economy remains challenging and significantly constrains economic activity.”

Policy makers issued new projections on Friday that showed the economy may contract 8% to 10% this year, a sharp revision of their outlook before the invasion. Inflation is set to reach 18%-23% at the end of this year, according to the central bank.

Cheaper borrowing costs will complement a slew of other measures by the Bank of Russia after signaling that it won't fight inflation “at any cost.” Nabiullina has warned that Russia is entering a period of transformation because sanctions imposed in punishment over the invasion will disrupt supply chains and deprive businesses of many imported components.

What Bloomberg Economics Says...

“With a tight grip on capital markets, the Bank of Russia is in an hurry to cushion the impact of sanctions on the economy. Fragile sentiment and high inflation will constrain how much further it can cut, but there's no use in waiting.”
--Scott Johnson, Russia economist. For the full react, click here.

Economic distress will become more apparent in the months ahead, setting the stage for one of the deepest downturns in modern Russian history. Despite a slowdown in short-term inflation, price growth on an annual basis will likely continue to accelerate and may peak this fall, said Bank of Russia Deputy Governor Alexey Zabotkin, who appeared alongside Nabiullina on Friday.

Still, banks have returned to a liquidity surplus and the ruble has rallied, thanks in large part to higher commodity prices and capital controls. The Russian currency has gained nearly 14% against the dollar this month.

The current account surplus that's been helping to limit the impact of sanctions will be bigger than expected, according to the central bank, reaching $145 billion this year as imports drop more than exports, buoyed by higher energy prices.

Inflation risks “remain substantial,” it said, noting that reducing price growth will depend in large part on Russia's success in adapting to sanctions and replacing imported products that are no longer available.

“Companies are experiencing significant difficulties in production and logistics” with access cut off to key imported supplies, the central bank said. The shift to new markets for exports and imports will be “gradual,” the central bank said.

The latest message of policy makers likely removes the chance of more unscheduled decisions in the months ahead and probably means the key rate won't go below 10% before next year, according to Natalia Orlova, economist at Alfa-Bank.

It's a “rather conservative” approach, she said.

With assistance from Bloomberg