Russia Inflation Monitor - Disinflation Starts in May

Inflation decelerated in May, with the annualized figure falling below 4%. Though it could slightly pick up in June on higher food prices, it should stay well below the CBR's target of 4%. We think this was a key factor in Friday's 100 bp rate cut to 4.5%, with the CBR citing a high risk of inflation remaining below its target. More cuts could follow. > Annualized inflation moved below 4% in May. Headline inflation decelerated to 0.3% m-o-m in May from 0.8% in April. Core inflation, as calculated by the State Statistics Service (removing the most volatile components, including fruit, vegetables and gasoline and regulated prices for utilities and transport), also decelerated to 0.3% m-o-m from 0.5% in April. Our estimate of modified core inflation (15% of the most volatile items removed) - a preferred measure of the CBR, as it is less affected by one-off nonmonetary changes - also decelerated in May to 0.30% m-o-m from 0.37%. In annualized terms, both official core inflation and our modified core inflation estimate moved below 4%, marking the start of a disinflationary trend. Meanwhile, the annualized estimate based on the three-month average remained above 4% due to the impact from March-April.> Inflation could edge higher in June on rising food prices. Weekly estimates showed that prices were up 0.1% in the first half of June. Given this, we believe inflation will come in at 0.2-0.3% for the whole month. Last year, cold weather and a late start to the harvest resulted in relatively high food inflation in March-May, followed by deflation in June. This year, food inflation has been more typical, meaning that it could be higher y-o-y in June. This could push the headline m-o-m figure into positive territory, above the zero reading from June 2019.> Inflation expectations stabilizing. The public's inflation expectations were mixed at the beginning of June. (The CBR was forced to change the methodology for its inflation expectations survey at the beginning of April, switching to telephone calls, which has made the data incomparable with surveys before April.) The share of those expecting inflation to accelerate in the following month declined to 56% in the first week of June from 59% at the beginning of May and 63% at the beginning of April. However, longer-term inflation expectations continued to rise, with the share expecting higher inflation next year climbing to 59% from 53% in April-May. Meanwhile, analysts' inflation expectations, calculated as the average forecasts collected by Bloomberg for 2020, eased slightly at the beginning of June to 4.10% from a peak of 4.35% in April. They were unchanged for 2021 at 4%.> CBR cut key rate 100 bps to 4.50% in June on rapid disinflation and sluggish economic activity. In its statement, the CBR said that the boost to inflation from the ruble depreciation in March-April has faded and that inflation has moderated. Currently, the CBR sees the risk of inflation remaining below the 4% target in 2021 as well. Yet with the economic recovery sluggish and causing disinflation, inflation was running at close to 3.1% y-o-y in the first half of June, and we expect a year-end figure of 3.6%. This means that the CBR has scope to make further rate cuts this year, bringing the key rate down to 4%.