CBR First Dep Governor Alexei Zabotkin: Altering market expectations can do more harm than good when range for rate decisions is broad
Photo: Bank of Russia
The Central Bank of Russia, which has raised its key policy rate 3.25 percentage points this year, continues to convince all of its unswerving commitment to bring inflation back to its target level. First Deputy Governor Alexei Zabotkin gave an interview to Interfax in which he spoke about the rate scenarios for the December policy meeting, the need to adjust signals ahead of policy meetings, the current inflation situation and its outlook.
Question: The October decision to hike the rate by 75 basis points was influenced, the Central Bank explained, not only by inflation dynamics but above all inflation expectations and a substantial review of the forecast. “We are not in the fine-tuning zone,” its governor said. Does this mean we won’t be seeing standard rate changes of 25 basis point at forthcoming meetings? What conditions might bring the regulator back into the “fine-tuning zone.”
Answer: At the December meeting, the board will consider a broad set of alternatives, based on the data that will be available by then. Of course, as always, we will also take into account the situation in the financial markets, where there has been some increased volatility over the past couple of weeks. It will probably be possible to talk about "fine-tuning" with confidence only when there is convincing evidence that the level of the key rate is commensurate with the robust component of inflation and increased inflation expectations. Regarding the standard increment: if you look at 2017, when the key rate was at a level comparable to the current one, or slightly higher, then there was a combination of 25-50, so I would not be so sure that 25 is a standard increment.
Q.: The 25 bps increment will not be on the table for the December meeting, or does the wide range of possible increments include that?
A.: It’s definitely included in the range of the average key rate envisaged by the October forecast, but it is unlikely.
Q.: Is the range of increments at the December meeting limited to 100 bps, or is it something else?
A.: The board will be looking at a wide range of alternatives.
Q.: In what instances do you see the need to alter market expectations? When they are way off the mark, or is some other factor taken into consideration?
A.: If we realize that the market is way off the mark in terms of the range of increments that the board is likely to look at, then it would indeed make sense to make some alterations. When the range is broad, as we have discussed – and it will be a broad one in December as well – then any attempts to alter expectations might do more harm than good. Since markets, analysts and the media often tend to interpret the messaging of central banks too literally not just here but the world over, then this might going forward complicate an explanation of the decision, if it ultimately does not match that interpretation that will be prompted by additional communication.
Q.: To go back to the subject of inflation. You don’t particularly like to assess the situation based on weekly data...
A.: No, we don’t like doing this at all.
Q.: According to Rosstat data, weekly inflation accelerated to 0.5% and the annual figure to 8.4% at the beginning of December. Is the Central Bank not alarmed by these figures? Even with a margin of error, does the picture indicate a worsening of the situation with inflation?
A.: I’ll repeat what I always say. The weekly price statistics are certainly up-to-date and, in this sense, are valuable in order to understand in which direction inflation dynamics are moving, though they do have considerably more limited coverage than the general consumer price index. It is representative of the whole country, though the data points are fewer in weekly data than in monthly data. Accordingly, these measurements are less reliable. In conditions when we have very significant fluctuations associated with one-off factors for a wide range of product groups, then weekly statistics are not really those on which the Central Bank could comment meaningfully.
"We rely on monthly data. It is naturally very important for us, especially now, not only the overall figure, but also the composition of the prices from which the index has ultimately formed. There have been enough instances this year, when the set of weekly price increases has not coincided very closely with the monthly figures, which in fact formed before this. This is a clear illustration of the fact that it is not very productive to draw exhaustive conclusions based on weekly inflation. We are waiting for the data for November as a whole. The Board of Directors will look at them very carefully.
The data for the last week of November include a seasonal increase in prices for New Year's holiday travel packages, and apparently the very same substantial recalculation to the monthly data of previous weeks that I have already mentioned. Given these considerations, I do not think that this week shows an acceleration in growth, though it does demonstrate that there was no significant decline in sustained inflationary pressure in November.
Q.: Developed countries, especially the United States, are seeing their highest inflation in recent years. How might this situation affect emerging markets, including Russia? How big are the risks for Russia due to a possible increase in rates and the tapering of quantitative easing? Is there a risk of increased capital outflow? How might the Bank of Russia respond to these threats? To what extent would a further increase in the key rate in Russia help mitigate these risks?
A.: Our forecast takes into account the inevitable normalization of monetary policy by the largest central banks. Our assumptions regarding global monetary policy are reflected in all scenarios of our guidelines. The October round of forecasts are generally in line with current market expectations and the communications of central banks.
The rhetoric of the central banks in developed countries reflects increasing concerns about inflation. This was evident in recent weeks. It cannot be ruled out that normalization will occur faster. It is already happening, for example, the tapering of asset purchases in the United States is already under way. Of all the central banks, only the European Central Bank has yet to begin normalization. This is part of the forecast. Expectations are now based on the fact that the Fed and the ECB are very focused on explaining the upcoming changes in monetary policy to the market in detail and well in advance. At the moment we see that it is working. Should more volatile conditions arise, we always have the tools in our financial stability arsenal to respond to this. Of course, the global monetary policy normalization path also influences our policy to some extent.
Q.: How, according to your forecasts, will the situation in the Russian economy unfold in Q4? Is it likely that GDP dynamics will be closer to the upper limit of your range by the end of 2021?
A.: The Q3 data were entirely in line with the forecast for the year of 4-4.5%. It is hard to talk about Q4 because we do not even have the main indicators from Rosstat for October. We only have operational and short-term indicators (plus railroad transportation, electricity), a rather limited set of data. Generally, what we know about October fully confirms what the board of directors has been planning for this year. Nothing super interesting could be added here: plus 4%-4.5%. Naturally, the non-working days will be subtracted from the fourth quarter, though in terms of the year, this will most likely not be a very substantial value.
Q.: Is the Central Bank worried about the labor market situation? How high are the risks from record low levels of unemployment, wage growth, and how high is the pro-inflationary effect of this factor?
A.: In October it was noted that the board of directors is closely monitoring the situation in the labor market, but at the moment we are still not classifying the situation as “overheating” of the labor market. If we look at the growth of nominal wages (about 8% year-on-year, slightly higher), this is generally within their growth range for 2016-2019. There is indeed a shortage of specialists in certain industries, the number of vacancies is noticeably higher than it was two years ago, but as of now there is no excessive pressure on wage trends. So for now we do not consider this to be a pro-inflationary factor, but we certainly understand, seeing this picture, that the balance of risks is shifted to the pro-inflationary side. We are watching it, as are other central banks.
Q.: In its monetary policy, the Central Bank takes into account the budget and budgetary policy. There was a substantial budget surplus for the 10 months. Do you expect there will be a surplus at the end of the year, and what kind of surplus?
A.: With regard to budgetary policy, we are always extremely laconic. I will not deviate from this practice. All I will say is that the budget balance this year will differ from what was set for this year by the amount of windfall oil and gas revenue. Taking this into account, it is indeed possible that there will be a certain surplus at the end of the year.
Q.: What, in your opinion, will the inflation situation in Russia be until the end of the year? Do you see the likelihood of year-end inflation exceeding the upper limit of your range?
A.: Predicting inflation for a month in advance is a thankless task, especially at times like this, when there are a lot of one-off factors, and a lot of them in some groups of goods. I want to emphasize that what will be important for the December decision is not just and not so much what inflation will look like at the end of December but understanding how much the October-November data collectively add to our understanding of the stable level of inflationary pressure that determines the degree of inflationary pressure next year. That's what's going to underlie the decision. Plus the picture of inflation expectations is also very important for us, because this is a significant driver of this very stable inflationary pressure.
Q.: In what part of the coming year do you expect a sustained deceleration of consumer price growth to begin?
A.: We do not give forecasts by the month. On a quarterly basis, we think it will unfold throughout the year. I must say right away that here it is necessary to distinguish between the dynamics of the current price growth, month-on-month or quarter-on-quarter in seasonally adjusted terms, and the dynamics of the annual inflation rate (the overwhelming majority of observers focus more on this).
Both will come down, but even with a significant decrease in the current rate of price growth, the annual rate may remain relatively high, significantly above our target for the better part of the year due to the fact that it will still contain the high inflation for September-October of this year. Only when these high values move out of the annual inflation calculation window, which will happen in October inflation next year, only then will the level of sustained price growth be fully visible. Up to and including September of next year, this year's high values will buoy annual inflation.
Q.: So the temporary factors will disappear altogether by September?
A.: We think the sustained component of inflation will return to 4% by the end of next year. This is what corresponds to the forecast of 4-4.5%, it is not 4%, but precisely 4-4.5% due to the fact that we are coming to the target from above. In the first half of the year the current price growth rate will probably be slightly above 4%, respectively, on average over the year it will be slightly above 4%, even if the price growth at the end of next year is already 4%.
This is exactly as it was following the low inflation of 2019 - our forecast for inflation in 2020 was 3.5-4%, because we converged on the target from below. As a result, life made its own adjustments, and inflation accelerated more significantly in 2020.
A lot of the one-off factors that have already materialized really will peter out by the end of next year, although this is more related, for example, to foodstuffs. As for more lasting factors, which are also usually called temporary, that is, bottlenecks in manufacturing chains and logistics (containers, microchips, etc.), most likely, these factors may to some extent continue to have an effect in the second half of next year. But their role will probably be much lesser than this year.
Q.: Given that you expect annual inflation to remain above your target for most of next year, how will inflation expectations unfold? Will they also remain elevated for most of the next year? With what sort of lag might they start to decline after inflation slows?
A.: This is a very good question. So far, our history of inflation targeting and the behavior of inflation expectations amid inflation returning to target is not very long. On the whole, it is evident that inflation expectations are quite in step with the annual inflation indicator, and the inflation that is observed behaves in approximately the same way. It is important that in terms of direction of movement, it will be more or less synchronous. How fast this movement will be is an open question.
Inflation observed by households is higher than that measured by Rosstat, and it quite closely follows the dynamics of prices at 10% of the fastest rising goods. Expected inflation already depends on this inflation. If this 'upper tail' of the price growth rate slows down faster than main inflation - and it most likely will, because the damping in temporary factors is connected precisely with the fact that this 'tail' will return to normal - then one could expect that inflationary expectations in general should decline in tandem, though faster than overall annual inflation. While this is a hypothesis, the risks are probably biased toward the fact that this should happen more slowly. Most likely, we are not ready to account for a very rapid decline in inflationary expectations thus far in our decisions on monetary policy.
Q.: Is your own perception of inflation higher than the official data published by Rosstat?
A.: There’s no doubt that inflation has accelerated. And the fact that the rise in prices for the range of everyday purchases is a little higher than the 8% seen in October for the whole consumer basket – this is also true, it can be seen from the data. In everyday goods, food occupies a larger share than in the overall consumer basket. But housing and utility charges, which are 10% in the basket, were raised by the targeted 4% this year. But even I am inclined to pay attention to where prices rise faster than where they are little changed. This also skews the perception of inflation. We have to take this into account when making our decisions, because it is the inflation perceived by households that ultimately influences consumer and savings behavior, for example, a decision to buy a new telephone or put money on a deposit. This is part of our monetary policy transmission.
If we talk about inflationary expectations, then, of course, my expectations are markedly lower than those of households in general.
Q.: You simply believe more that inflation will return to target by the end of 2022...
A.: I am absolutely convinced that monetary policy is a very powerful tool, and is capable of bring inflation back to the goal set by the Central Bank. Again, we demonstrated that this can be done in a relatively short period of time after 2015. If the Central Bank is consistent in achieving its goal, then in two years it is capable of returning inflation to target even from very high levels. In actual fact it is very noteworthy that inflation of 8% is now perceived as being something out of the ordinary. Five years ago, inflation of 7-8% was perceived as the usual state of affairs. This shows that society has appreciated the importance of price stability, which means that what we do really is of value to it.