The Bank of Russia at the meeting of the Board of Directors on Friday, June 19, will reduce the key rate by more than 0.5 p. p. from the current 5.5%, analysts polled by RBC predict, and the Bloomberg consensus forecast evidences, according to which most of the 37 economists expect the rate at 4.5%. The Central Bank, on the background of the pandemic lowered the rate from 6 to 5.5%, i.e. to the lowest level since 2013. The bank has repeatedly hinted that it is ready to take more drastic scenario: the rate may be reduced immediately by 1 percentage point, which did not happen in Russia in 2015, when the Central Bank lowered it from unprecedented 17% on the backdrop of a gradual exit from the crisis 2014. Now the situation is reversed — the regulator reduces the rate in the midst of a crisis in the economy.
Arguments for a key rate of 4.5%
The probability that the Central Bank will reduce the rate by 1 p.p. (100 bps) is 70%, the second option — a decrease of 0.75 p.p. — was suggested in the review by Citi analysts. The Bank of Russia has been "very careful in managing market expectations" for several press conferences and is now unlikely to miss the chance for a decisive decline. In the main scenario, the rate will be 4.5% — the lowest level in the history of the inflation targeting regime in force since 2014.
The market was prepared to mitigation by the Chairman of the Bank of Russia Elvira Nabiullina. "I confirm once again that we see room for a rate cut, and the option to reduce the rate by 100 bps will be considered among other options at the next Board meeting", she said at a press conference on June 5.
Almost all economic data published since the last meeting (April 24) turned out to be more favorable than the Central Bank's forecasts, according to Alexander Isakov, economist of “VTB Capital” for Russia and the CIS: inflation is slowing faster, while business activity has decreased less significantly and is recovering more quickly. "For interest rate policy, the effects of these data are the opposite: a moderate increase in prices allows policy to be mitigated faster, but a more favorable situation in the labor market and the overall level of business activity remove some downward pressure", Isakov explains. A 1 p.p. decline is more likely, although it may be accompanied by "a relatively strong signal that such a significant mitigation will be followed by some period of observation of deferred effects without further mitigation of rates", believes the analyst.
"Now there are many factors that give room for maneuver: slowing inflation, a very strong ruble, economic activity is recovering, but it is clear that the process will not be fast", says Sofia Donets, an economist at “Renaissance Capital” for Russia and the CIS. She also believes that the rate cut will be 1 p. p. But the analyst sees the 4.5% level "as the final point of the reduction cycle", the next stage will be a return to a neutral monetary policy with a rate of 6-6.5%.
In May, inflation returned to the level of 3% in annual terms after 3.1% in April, remind analysts at Nordea Bank in their review. After a 23% fall in trade turnover in April, "the recovery of domestic demand to pre-crisis levels will be very gradual and may take at least two years", they believe: in these conditions, the Central Bank should maintain soft monetary policy conditions and will most likely reduce the rate by 1 percentage point.
Arguments against a sharp decline
"The mood in global markets is not very good at the moment, there are concerns about the second wave of the epidemic. In such circumstances, it may be more important for the Central Bank to leave the tools to support the economy for the future", says Natalia Orlova, chief economist at Alfa Bank. If the rate is cut by 1 percentage point now, the potential for mitigation in the future "will be more limited". "In addition, the decline by 100 bps looks quite force majeure, it is unlikely that the Central Bank is now interested in any escalation of sentiment. All the last comments sounded like the situation is normalizing", adds Orlova.
According to her estimates, at the next meeting, the key rate will be reduced by 75 bps, in July - by another 50 bps, and in September - by 25 bps. "For now, this is the basic scenario — fading mitigation. Depending on what happens in the world, [whether there is] a second wave of a pandemic, the Central Bank will look at how to proceed. So far, the benchmark rate for the end of the year is 4% with inflation of about 3.6%. But the probability that we will go lower increases", she notes.
The Central Bank will reduce the rate by only 50 bps, believes Nikolay Minko, strategist of Sberbank for currency and interest rate markets. "If the bank chooses to reduce the rate by more than 50 bps in June, this will mean that the key rate will reach the level of 4% in July. Such a rapid reduction in the key rate may lead to a correction in the Federal loan bonds market and make it more difficult for the Ministry of Finance to place securities", -said in his comments, distributed by the Bank's press service.
On the other hand, it is never too late to create an incentive for the economy, says Donets: "On the contrary, by the second wave [of the coronavirus pandemic], this incentive will be able to "be absorbed" by the economy to some extent".
Neutral and negative rates
The question is whether the regulator will change its view of the neutral rate due to policy mitigation (now it is the key rate plus 2-3 percentage points, that is, with a 4% target, the neutral range is 6-7%). It is unlikely that the Central Bank will shift this value in the near future, says Orlova: "If the Central Bank after the rate cut also reviews the neutral rate interval, it will turn out that there was no stimulus. I think that the revision of the Central Bank's neutral rate will be made at the moment when there is a risk of raising the key rate".
The Central Bank has already indicated last year that uncertainty around the assessment of the neutral rate has increased, Isakov notes. The data on inflation suggests that it should be revised, and this issue should be raised again, he adds.
At the height of the crisis, the market also discussed moving to a really negative key rate (i.e. a rate below inflation). However, at the end of May, Nabiullina said that "the Board of Directors does not see the need to switch to negative real rates in the basic scenario in the foreseeable future". Taking into account the Central Bank's lack of desire to move to a negative key rate at the end of the year, its level may be 4%, write analysts of Citi.