Russia Inflation Monitor - Still No Upward Pressure in July

Headline y-o-y inflation accelerated to 3.4% in July, though the increase was driven mainly by food price dynamics. Modified core inflation (which strips out the most volatile components), on the other hand, slightly eased from the June level and suggests that there has been no upward pressure on prices for the last three months. In annualized terms, it remains below 4%. Analysts' inflation expectations for 2021 declined to 3.5% in July, which means that the market is becoming more confident that the CBR will undershoot its inflation target of 4% next year.> Modified core inflation slightly eased in July. Headline y-o-y inflation continued to accelerate in July, reaching 3.4% y-o-y, up from 3.2% a month before. However, this was mostly attributable to a slower drop in food prices this year (they were down 0.1% m-o-m this July versus 0.3% last July). Accordingly, core inflation (which excludes fruit and vegetable and regulated tariff prices) picked up only slightly, to 3.0% from 2.9%. Moreover, modified core inflation, which strips out 15% of the most volatile components and is a better measure of underlying monetary inflation, slightly eased, to 0.29% m-o-m from 0.32% in June, which lowered the one-month and three-month-average annualized figures to 3.5% and 3.7%, down from 3.9% and 4.0% in June.> Deflation underway in August. Prices in Russia fell 0.1% over the week ending on August 10. This was the first week of deflation this year, although prices had already begun moving lower over the first three days of August. A decline in prices on fruits and vegetables of 2.8% (last week saw a 2.3% contraction) was the main factor driving prices down. Given that deflation will likely continue in the following weeks due to the arrival of the new harvest, prices may drop 0.2-0.3% m-o-m in August, in line with last year, which would result in a stabilization of the headline y-o-y figure.> The population's inflation expectations were virtually flat in July; market analysts now expect 3.5% inflation in 2021. The Russian population's short-term inflation expectations slightly increased at the beginning of July, having bottomed out in June. This may have owed to the utility tariff indexation at the beginning of July. Meanwhile, Russians' long-term expectations were flat, with the share of respondents who expect higher inflation in the next 12 months remaining at 61%. According to the Bloomberg consensus, analysts still expect inflation to end this year at 3.7% and average 3.5% next year. However, their 2021 year-end inflation expectations eased to 3.5% from 3.6% in June. Businesses' inflation expectations also eased slightly in July.> The CBR cut the key rate by 25 bps to 4.25% on July 24. While this was its fourth cut this year (200 bps in total YTD), it was smaller than the 100 bp cut in June and the 50 bp cut in April. The still-weak economy and the persisting risks of undershooting the 4% inflation target this and next year were cited as the main factors behind the decision. While the CBR has signaled the possibility of further rate cuts this year, as the economy remains weak and inflation will most likely remain below target (our year-end forecast is 3.6%), it is likely that the room for further easing is limited. We expect another 25 bp cut in September. The regulator now anticipates a 4.5-5.5% GDP contraction in 2020, having narrowed its initial forecast range of 4.0-6.0%. It then expects economic growth to rebound to positive 3.5-4.5% next year (up from 2.8-4.8% previously) and then slow to 2.5-3.5% in 2022 (versus the previous 1.5-3.5%). It now projects inflation of 3.7-4.2% this year (versus 3.8-4.8% in April), 3.5-4.0% in 2021 (versus 4.0%) and 4.0% in 2022 (the same as before). During the press conference after the July meeting, Governor Elvira Nabiullina said that the CBR currently sees the real neutral key rate at 1-2%, down from 2-3% previously.