CBR Review - CBR Accelerates Policy Normalization

The CBR raised its key rate today by 50 bps to 5.00%, as we had expected. It noted that inflation remains elevated, which it attributes to the ongoing recovery in consumption in the economy amid upward pressure on producers' costs. At the same time, the bank only slightly altered its guidance, saying it would now "assess the feasibility of further raising the key rate" at coming meetings. In our base case, we see another 50 bp hike coming up at the June meeting.> The CBR revised upward by 1 pp its year-end inflation forecast for 2021 from 3.7-4.2% (issued in February) to 4.7-5.2%. According to the bank, inflation has recently remained above both the regulator's forecasts and levels corresponding to the CBR's year-end target of 4%. In the near future, pro-inflationary risks are expected to continue to prevail as demand growth continues to outstrip output. According to the CBR, while the recent acceleration of inflation is partly attributable to one-off/temporary factors, to a large extent its nature is monetary. Meanwhile, the pro-inflationary risks are aggravated by the fact that demand could receive additional support in the near future from a falling propensity to save among the public against the backdrop of recovering incomes and increasing lending, as well as possible spending of funds unspent last year on foreign travel.> In these conditions, the regulator saw risks in a protracted tightening of monetary policy. The CBR noted that the decision to move faster toward a normalization of monetary policy will allow inflation to reach its target more quickly and may help avoid having to resort to a tight monetary policy during this hike cycle. During the press conference Governor Elvira Nabiullina stated that at this meeting only two options were considered: hikes of 25 bps and 50 bps.> The CBR noted the need for an earlier than previously expected return to a neutral monetary policy (before it had only said that such a need had emerged). In particular, it said that it would "assess the feasibility of further raising the key rate" at coming meetings (before the wording was that it "allows for the possibility of further raising the key rate" at coming meetings).> The CBR also published a new forecast showing what it expects the average key rate and full-year inflation to be in the years 2021 to 2023. It sees the key rate averaging 4.8-5.4% in 2021, and then rising to an average of 5.3-6.3% in 2022 and 5.0-6.0% in 2023, with inflation projected to run at 4.7-5.2% in 2021 and 4.0% over 2022-23. We did some quick math to come up with a trajectory for the key rate corresponding to these forecasts. The results are shown in the chart below. Interestingly, in the optimistic scenario, with the key rate averaging 4.8% in 2021, we see the CBR keeping the key rate unchanged at 5.00% until close to the end of the year, before raising it to 5.25% for most of 2022 and then lowering it back it to 5.00% in 2023.> In the pessimistic scenario, where the key rate averages 5.4% in 2021, we see two more 50 bp hikes in June and July, and then a 25 bp hike in September this year, bringing the key rate to 6.25%. The CBR could also follow up its two 50 bp hikes in June and July with another 50 bp hike in October, but in this case it would most likely cut to 6.25% in the beginning of 2022. We would then expect the key rate to be kept at 6.25% in 2022 and lowered to 6.00% in 2023. This all leads us to believe that the CBR retains a view that the neutral range for the key rate is 5-6% in nominal terms.> As for our current base case, we expect the CBR to deliver another 50 bp rate hike in June, as we think it would prefer not to drag out policy normalization given its recent rhetoric and the persisting pro-inflationary risks. We therefore think the ruble rate curves will continue to flatten. It is important to note that in its updated forecast the CBR expects the average key rate to be no higher than 6.3% in 2022 and 6.0% in 2023. The long end of the OFZ curve, meanwhile, is pricing in considerably more hawkish policy than this over the long run. We therefore maintain a positive view on long-dated OFZs.