TEXT-Statement by Elvira Nabiullina, Head of CBR, after the meeting of the Board of Directors

MOSCOW, July 21 (Reuters) – The Central Bank of Russia decided on Friday to raise its main interest rate by 100 basis points to 8.50% per annum.

Below is the text of the statement of the president of CBR Elvira Nabiullina after the meeting of the Board of Directors:

Good morning. Today we have decided to raise the main interest rate to 8.5% per annum. There have been significant changes in the economy in recent months. The first of them is the end of the recovery phase of economic growth, activation of consumer demand and deepening labor shortage. The second is the acceleration of current inflation rates, including its stable components. Third, the weakening of the ruble. Fourth, rising inflation expectations. This required a tightening of monetary policy. It aims to bring inflation back to 4% next year. I will consider the arguments for today’s decision. First. Price pressure is intensifying. The seasonally adjusted monthly price dynamics continues to increase, and most of the indicators of permanent inflation exceed 4% y/y. The increase in inflationary pressure is primarily related to demand. During the period of economic recovery, demand was mainly supported by the public sector, and demand from the state remains at a high level. Consumer demand was limited until the end of last year. From the beginning of this year it has intensified, due to the increase in wages and consumer sentiment, and in the second quarter it accelerated further due to the rapid expansion of lending. When demand begins to systematically exceed the capacity to increase supply, this inevitably results in higher prices, because companies cannot immediately start new production facilities and find additional labor for them. There are striking facts illustrating this situation. For example, a sharp increase in demand for domestic tourist services. The Russian hotel industry needs time to adapt to this increase in demand: build new hotels and create comfortable accommodation. In addition, carrier costs have increased significantly. But it was the high demand that allowed companies to pass them on prices. Another example can be given where increasing demand is constrained by a rapid expansion of supply. This is the car market. In our report on the state of the economy of the region, we analyze this situation in detail. The increase in demand also contributed to a rapid revival of imports, which, together with the decline in exports, contributed to the weakening of the rouble. Recent movements in the exchange rate have not yet been fully translated into prices. In addition to the direct impact of changes in the ruble exchange rate on prices, we are concerned about possible side effects. The dynamics of the exchange rate affects the inflation expectations of the population and enterprises. They remain elevated and unanchored. And in July they grew. We will closely monitor the further dynamics of inflation expectations and take them into account when making decisions. Taking all factors into account, we raised the lower bound of the inflation forecast for the current year by half a percentage point. Inflation will be 5.0-6.5%. The conducted monetary policy will limit the scale of deviations of inflation from the target and will strive to bring it back to the level of 4% by the end of next year. Second. About the economy. The recovery phase of economic growth is coming to an end. It was characterized by high quarterly GDP dynamics. They are due to the fact that the recovery includes free resources, labor and production plants that were idle during the downturn. Currently, in addition to historically low unemployment, according to corporate monitoring, there is a historically high capacity utilization. It also indicates that economic growth is nearing completion. Thereafter, the growth rate of the economy usually enters a balanced, more moderate trajectory. Overall, the economy is back to pre-crisis levels, apart from the oil and gas sector, where there are severe external sanctions. However, structural changes in the economy have resulted in considerable variation across industries and regions. In most of those that focus mainly on domestic demand, we have not only reached pre-crisis levels, but are even starting to exceed them. In the rest of the export-oriented economy, the possibilities for a full revival of production remain limited. Another key limitation of the acceleration of output growth, which is manifested to some extent in all sectors, is the shortage in the labor market. Thus, according to our monitoring data, about three-quarters of mechanical engineering companies reported staff shortages. The unemployment rate reached a historic low again. Some companies have been forced to employ workers in multiple shifts, and both labor and capacity utilization have increased overall. The problem of shortage of labor resources is particularly acute in those regions whose economy is developing at a fast pace. The low geographic and cross-sectoral mobility of staff exacerbates this problem. Taking into account the rapid revival in demand, we raised our GDP growth forecast for this year to 1.5-2.5%. Third. On monetary terms. Although nominal interest rates, including OFZ yields, have increased since the previous meeting, overall monetary conditions eased, mainly due to non-price considerations. This is evidenced by the continued strong growth in lending in all market segments. Particularly active is the retail trade, where the growth rate of mortgage loans is close to the peaks in recent years. The acceleration of lending to the public is associated with an increase in income and takes place against the background of increased inflation expectations. Increased inflation expectations are an important factor in easing monetary conditions. Based on these trends, in our updated forecast, which takes into account monetary policy tightening, we raised our estimate of credit growth to the economy for this year to 13-17%, which is above the average of the last five years. Let’s move on to the external conditions. The pace of global economic growth is slowing down. This is reflected in the prices of Russian exports – gas, coal and fertilizers are getting cheaper on the world market. Thus, Russian exports are under double pressure – both from sanctions and from the economic cycle. Along with the increase in imports, this led to the dynamics of the exchange rate observed this year. The dynamics of the ruble has attracted a lot of attention recently, so I will discuss it in more detail. In our opinion, the main factor affecting the movement of the exchange rate in the June-July period are the consequences of the decline in exports that took place in recent months, accompanied by an increase in imports. Usually depreciation leads to a reduction in import demand, but so far this has not happened. There are two reasons for this. The first is contract delay. The imports currently entering the country were purchased at the exchange rate on the date of the supply contract some time ago. The second and main reason is that as domestic demand increases, import demand also increases. According to this logic, the weakening of the exchange rate is another confirmation of a significant increase in domestic demand. Apart from export-import operations, the exchange rate was affected by flows in financial accounts. So, last year there was an increase in transfers of funds from the population to foreign accounts. Many wondered how this affects the dynamics of the exchange rate. Here the following comparison will be clear. Last year, the exchange rate strengthened for most of the year, and transfers of funds by individuals to foreign accounts were significant. In the first half of this year, remittances were roughly half as much as in the second half of last year. And this year their volume practically does not change from month to month. Other components of the financial account also decreased significantly compared to the second half of last year. This also applies to transactions related to the decisions of the Governmental Commission for Foreign Investment Control, which were minimal in May-June. Therefore, in general, the capital flow factor was no longer decisive for the dynamics of the exchange rate. The most important is the dynamics of exports and imports. Now about the dangers. In the forecast horizon, pro-inflationary risks increased significantly. We take into account the possible widening of the gap between demand growth and supply capacity, including due to the continued high growth rate of consumer loans and further deepening staff shortages. Pro-inflationary threats also include a stronger impact of the ruble depreciation on prices and long-term persistence of inflation expectations at an elevated level. The deterioration of external conditions, including a possible tightening of the sanctions regime, remains a significant risk. The risk of disinflation is low. In conclusion, about the prospects of our policy. Given the changes in our assessment of the economic situation, a higher path of key interest rates will be necessary to end the next year with inflation at the target of close to 4%. The updated outlook includes an upward revision of our estimate of the neutral rate by 0.5pp to 1.5-2.5% in real terms or 5.5-6.5% in nominal terms. The estimate of the neutral rate was increased due to the increase in the risk premium for the Russian market and the increase in the external neutral rate. According to the updated forecast, the average annual key interest rate for this year has been raised to 7.9-8.3%, and for next year to an even greater extent to 8.5-9.5% pa. At the next meetings, we allow for the possibility of further price increase. The step of possible growth will be determined by the extent to which the incoming data will affect our assessment of developments and the balance of risks for achieving the inflation target of around 4% in 2024. Thank you for your attention!

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