Chief Economist's View - Why We Think the June Inflation Uptick Will Be Temporary

Monthly inflation came in at 0.6% in June, versus 0.4% in June 2016. In y-o-y terms, inflation climbed to 4.4% from 4.1% in May. Year-to-date inflation reached 2.3%. We consider the rise as temporary and do not think it offers any significant upside risk to the 4% annual target.
Inflation in the fruit and vegetables segment was the main driver, as prices jumped 8.3% compared with deflation of 1.1% in June 2016. In other segments, inflation was down y-o-y (excluding the services segment, where prices rose 0.7% versus 0.6% in June 2016). We calculate the CPI excluding fruits and vegetables at 0.3%, versus 0.5% in June 2016. So excluding fruits and vegetables, the inflationary environment remained calm.
Within the fruit and vegetables segment, price movements were extremely mixed in June. Cucumber and tomato prices dropped 25.4% and 22.8%, respectively, while cabbage prices soared 50%, and the price of apples, oranges, beets, potatoes and carrots jumped 15.9-22.4%. We think inflation is being fueled by reduced supply in the agricultural sector on the back of cold weather. However, agricultural output should expand m-o-m in July-August and fruit and vegetable inflation should slow. This process has already started, as w-o-w inflation in the segment reached 0.7% in the week to July 3, down from the 2% seen over the previous two weeks. We expect deflation in the segment to start in the second half of July and the CPI to normalize.
The CBR also pays close attention to year-ahead inflation expectations, and a recent poll showed that these expectations did not change in June - as in May, respondents expected inflation at 10.3% in a year's time. Since expectations are typically much higher than the actual level (4.4% y-o-y as of end June) and targeted rate (4%), the CBR most likely focuses more on how expectations are changing than on the absolute level of expected price growth. The raw figures from the poll are biased, as the population usually misjudges the actual level of inflation. For this reason, the CBR also uses its own estimates of inflation expectations, which are adjusted based on respondents' views on the likelihood of an acceleration or deceleration from the current level. The CBR's adjusted estimate of expected inflation also remained nearly unchanged in June at 3.8%, versus 3.7-3.8% in May.
Among the other most important indicators for the CBR are wage growth and labor productivity. In April-May, real wages grew 3.7% y-o-y, while basic sector output increased 4.4% y-o-y. As employment was about flat y-o-y, real wage growth even slightly lagged the improvement in labor productivity. Thus, the situation in the labor market was at least not pro-inflationary, though we note that the unemployment rate was very low in May, at 5.2%.
The CBR might treat the uptick in inflation as a warning signal ahead of its next key rate decision on July 28. We think that the decisive factor for the regulator will be the w-o-w inflation data for the next three weeks, where the focus will be on fruits and vegetables. However, other indicators the CBR tracks (beyond fruit and vegetable prices) suggest disinflation will continue.