Fixed Income - CBR Could Consider Downward Revision of Inflation Target

Today, Interfax citing CBR Deputy Governor Alexei Zabotkin, reported that the CBR could consider tweaking its inflation target during the upcoming review of its policy framework, and potentially revise it downward. The near-term market implications of the news should be mild as the change is not a done deal and will likely be subject to a protracted public debate. However, the timing of the comments suggests that the CBR is becoming increasingly willing to anchor longer-term inflation expectations as soon as possible. That is supportive for further front-loading of rate hikes by the CBR and underperformance of shorter-term OFZ yields/swap rates versus longer ones. Further bear-flattening and inversion of the OFZ curve seem likely. > Importantly, Zabotkin emphasized that such a potential downward revision could be the result of a "deep review" of the monetary policy framework announced recently by CBR Governor Elvira Nabiullina, although it is not guaranteed. The results of the revision are expected to come only in mid-2022. Meanwhile, all near-term decisions are to be informed by the current 4% target. > As explained (available in Russian only) by the head of CBR's research and forecasting department, Alexander Morozov, a potential downward revision of the inflation target could help anchor inflation expectations at structurally lower levels. He argued that, according to surveys, inflation ceases to be the key point of concern for the population when it stays below 4%.> While we find it unlikely that the inflation target will be decreased in the coming months, the talk itself might be indicative of the CBR's priorities. This is especially notable in light of a series of hawkish comments from several CBR representatives over the last several days and in particular the statement by CBR Governor Nabiullina that even a 100 bp rate hike would be considered on July 23. Our reading of the CBR's latest communication is that it might be preparing the market for an even larger rate increase than the 50 bps delivered in April/June, which might be necessary to keeping longer-term inflation expectations at bay. > The talk bodes well for a further bear-flattening of the OFZ curve, in our view. In particular, we expect the 5s10s spread to soon move into negative territory (versus +15 bps now). We do not see much room for long-term OFZs to tighten in absolute terms at this stage, as their shrinking carry will likely keep local banks reluctant to buy them. Also, primary market supply will likely remain substantial (the Finance Ministry plans issuing R300 bln in long-term bonds in 3Q21). > If more signals appear that such a downward revision will take place, it could boost the flattening and inversion of the rate curves in our space further. In our view, the market will be pricing in the following chain of events: a commitment to lower inflation makes the CBR more concerned about the current spike of inflation => CBR tightens policy even more than expected in the near-term => longer-term rates decrease owing to the market's belief that the CBR will now set policy to keep long-term average inflation at 3%, on average (versus 4% previously).