In a significant move that reflects the ongoing economic challenges in Russia, the Central Bank of Russia has announced a decisive hike in its key interest rate, raising it by a full percentage point to reach 19%. This decision is grounded in the central bank's assessment of the prevailing inflationary pressures that continue to loom heavily over the marketThe bank's leadership contemplates that inflation could surpass previously estimated levels, indicating that the growth of domestic demand is outpacing that of available goods and services—a scenario that inevitably fuels price increasesThe central bank has underscored the urgency of tightening monetary policy further, aiming to temper inflation expectations and restore rates to target levels by the year 2025. Additionally, there are hints from the central bank that further rate increases may not be off the table in the upcoming meetings.

This recent rate adjustment marks the seventh consecutive increase since mid-last year

The rate of 19% now positions Russia's key interest rate at one of its highest points in recent history, sitting alarmingly close to the 20% mark observed in March to April of 2022—a period characterized by unprecedented sanctions and immediate economic turmoil which prompted the central bank to implement drastic rate hikes that were deemed necessary to counter both domestic and external shocks.

While the effects of these ongoing rate hikes have started to be felt, they are yet to fully mitigate the inflationary landscapeBank Governor Elvira Nabiullina has indicated that the tightening of monetary circulation in recent months has led to a deceleration in loan growth, particularly visible in the retail sectorHowever, inflation has proven to be resilient, with the prices still rising faster than desirable levelsAugust data from the central bank revealed a year-on-year inflation rate, after seasonal adjustments, of 7.6%, with the core inflation rate pegged at 7.7%. While both figures are below the average recorded in the second quarter of 2024, they unfortunately exceed those reported in the first quarter

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Hence, the decline in inflation rates has not solidified as a trend, and according to Dmitry Belousov, who heads the macroeconomic analysis and short-term forecasting center, while periods of accelerated inflation may have passed, it is too early to claim victory over inflation itself.

The inflation expectations harbored by Russian households and businesses continue to climb, suggesting that inflationary inertia remains in playExperts posit that a primary source of upward price pressure stems from inflation expectations, with a significant number of individuals expecting prices to rise furtherThis belief deepens market demand while simultaneously exposing supply gaps, amplifying price hikes.

Consequently, continuously raising rates has become the primary strategy for the regulatory body to tackle stubborn inflationNabiullina revealed that the central bank had previously considered three potential solutions: maintaining the existing rate of 18%, or raising it to 19% or even 20%. Given that the impacts of past rate hikes have yet to fully materialize, further tightening of monetary policy was deemed necessary

In the current economic landscape, the central bank seeks to demonstrate its unwavering commitment to controlling inflationSigns of economic slowdown are already becoming apparent, as indicated by GDP data for the second quarter of 2024 and economic indicators from July to August reflecting a deceleration in growthThe primary catalysts for this slowdown are increasing supply-side constraints and diminishing external demand.

Bringing together various perspectives, Russia's approach suggests an attempt to utilize rate hikes to influence the trajectory of inflation in two focal areas.

First, there is an effort to suppress demandAccording to AKSakov from the State Duma's financial market committee, raising interest rates should dampen loan activity, thereby alleviating market pressures from the demand side and limiting further price escalationsHe has also noted that the legislative body wishes for the alterations in key rates to rectify the situation where demand for commodities outstrips supply, thereby stifling the continued growth of inflation and signaling that prices are indeed under the central bank’s watchful eye.

Simultaneously, there is a concerted effort to manage market inflation expectations

Duma financial markets representative Safchenk has pointed out that elevating the key rate by a full percentage point will not fundamentally alter the overall state of the economy, asserting that it is more of a psychological responseThe increase to 19% is aimed at preemptively mitigating any potentially severe inflation-related scenarios that might arise in the futureAs such, the current rate hike is viewed as a temporary measure.

However, it is crucial to highlight that the current "cooling" measures primarily focus on demand suppressionAnalysts argue that under favorable financing policies, Russia's strategic industries will continue to receive financial support, while the primary issue revolves around consumer goods heavily reliant on importsThe ongoing sanctions have rendered import transactions increasingly complex and have slowed down the delivery of goods, prompting consumer anxiety regarding the sustained deterioration of import conditions

Experts from the Russian Academy of Sciences warn that without investments aimed at expanding production capacity, overcoming supply-side challenges will be impossibleHence, the Russian government has communicated to external observers that if there is no significant shift in inflation trends as a result of tightening monetary policy, discussions will be necessary on additional measures to bolster domestic production.

To summarize, the effectiveness of Russia's interest rate hikes in achieving desired outcomes remains to be seenThe inherent lag in policy impact suggests that a continuation of tight monetary policies is likelyNabiullina has indicated that the effects of the rate hike will be visible in inflation data within three to six quartersMoreover, according to Deputy Governor Zabotkin, a transition toward a more accommodative monetary policy will only be considered once inflation aligns with target levels, coupled with signs of severely underutilized production resources and rising unemployment rates.