Russia’s central bank to wait and see till December

We agree with the consensus view that the central bank of Russia has no urgency in changing the 7.5% key rate at the next meeting as current trends aren't in breach of the guidelines the monetary authorities provided after hiking rates in September.

• CPI growth has accelerated from 3.1% year on year in August to 3.4% YoY in September and may reach 3.6% YoY in October - predominantly as a result of the base effect in the food segment. However, the 3.8-4.2% YoY range targeted for the end of 2018 still appears realistic even if monthly inflation keeps increasing from 0.2% MoM in September to 0.4% MoM in October and 0.5-0.6% MoM in the following months.
• Households' expectations of CPI for the next 12 months have deteriorated slightly by 0.2 percentage points in September, but remain around the 10% level seen since June. The households' CPI expectations, as well as the perception of the current price growth, have historically been significantly more pessimistic relative to the official ex-post CPI metrics.
• Economic growth, according to preliminary government estimates, has slowed down from 1.9% YoY in 2Q18 to 1.3% YoY in 3Q18 amid some cooling in the consumer confidence. The resulting 1.6% YoY GDP growth in 9M18 is in line with the central bank's estimate of the potential growth rate of 1.5-2.0% and suggests there is no immediate risk of overheating.
• Since mid-September, when the central bank decided to raise rates and suspend the $5-6 billion monthly FX purchases for the Finance Ministry, the ruble has appreciated 4% to the USD, while the yield curve on the benchmark 2-10Y OFZ narrowed by 20-40 bps - suggesting calmer market conditions.

For now, we expect the key rate to remain unchanged until the end of 2019, but this view relies on Russia's ability to keep inflation within 6.0% YoY during 1H19 and 5.5% YoY by the end of 2019 - which the central bank has indicated as the upper forecast range. This forecast incorporates the effect of the upcoming VAT hike from 18 to 20% and the pass-through effect of the recent ruble depreciation.

We see three major risk factors, that may negatively affect inflationary expectations forcing the central bank to raise rates in the medium-term:

1. Persistently high or growing oil prices combined with local tax manoeuvring in the oil downstream and further hikes in excise could put additional upward pressure on the local gasoline prices. The local PPI, which is oil price-driven, has recently slowed down but at 11.1% YoY is still significantly above the CPI rate. The recent weekly CPI data shows consumer prices for gasoline have resumed weekly growth in October.
2. While we are expecting the ruble to return to the 60-65/USD range by the end of the year, this view is partially dependent on global emerging market flows, which are subjects to multiple risks, including Fed tightening, US-China tensions, etc. The CBR decision to put the FX interventions on hold might have absorbed some Russia-specific pressure on the ruble, but it hasn't made it immune to global trends. According to our estimates, two percentage points out of 4% the ruble's appreciation to USD since mid-September was attributable to USD's weakness against Russia's FX peers. The same principle applies to the benchmark rates on the local FI market: the recent decline in emerging market yields may still look like a correction relative to the upward move seen since spring 2018.
3. The likelihood of sanctions against new state debt has increased over the last couple of months. However, it remains unclear how much of it is already in the prices on the FX and FI markets. Non-residents have withdrawn some RUB 550 billion from the OFZ market since April, reducing their peak holdings by 25%, but the increase in yields and FX depreciation was in line with that of peers. This suggests that in case of sanctions against the new state debt acceleration in net capital outflow is still possible. According to our estimates, each $5 billion outflow lowers RUB fair value by RUB1/USD, but the initial market reaction may be stronger. Each 10% RUB depreciation adds 0.5-1.0 pp to the CPI trend on the six months horizon.