Russian inflation touched a nerve in September

Inflation has been the source of bad news for the most part of this year, but in September it got worse. The spike from 6.7% year-on-year in August to 7.4% YoY in September and 7.5% YoY in the beginning of October outpaced the latest 7.3% YoY expectations and is 0.3 percentage points higher than the rate we and the market expected only a month ago. Most importantly, core CPI jumped from 7.1% to 7.6%, the highest level since April 2016.

Here are our key observations and takeaways from the latest CPI print:

• Both headline CPI and households' inflationary expectations are now back to levels seen in 2016, when Russia was still suffering the consequences of the 2014-15 ruble devaluation, and the Bank of Russia was conducting a transition to inflation targeting through extremely tight monetary policy (Figure 1). However, this time inflation is accelerating despite the continuous ruble appreciation by 7% to the US dollar year-on-year and 2% year-to-date.

• Looking at the structure of the CPI growth, the food segment appears to be the key contributor jumping 9.2% YoY in September and contributing 0.5 out of 0.7 percentage points of the headline CPI acceleration in September vs. August. Non-food and services price growth also picked up, contributing the the remaining 0.2 percentage points (Figure 2).
• Noteworthy, the spike in food CPI took place despite the continued moderation in global agriculture prices, especially in wheat, Russia's key agriculture commodity (Figure 3). Local price pressure was concentrated in meat, dairy, select imported fruit and vegetables.
• Non-food CPI picked up despite the moderation in gasoline price growth (the latter is largely insulated from the global trends). The primary drivers were higher prices on cars (responding to a cut in production due to input shortages), select construction materials (on the continuing yet waning construction boom), and consumer electronics/appliances (due to global shortage-driven restrained imports).
• Acceleration in the services price growth is largely driven by the base effects, but the growing costs of international travel is also noticeable as the late opening of the travel season and cold September boosted demand for popular tourist destinations.

• The spike in weekly inflation from the normal 0.1% WoW to atypical 0.3% WoW, in the last two weeks took place immediately after the Parliamentary elections. Ahead of those, the government disbursed RUB700bn (c.US$9.5bn, or 1% of total annual household income) in social support payments in favour of schoolchildren, pensioners, and the military personnel, covering over 40% of the Russian population. The social support, which came in the end of August and early September may have eased the pass-through of elevated producer price inflation and expectations into the local consumer prices.
• The local PPI has been under upward pressure since the beginning of the year, responding mainly to cost inputs, such as higher prices of freight, microchips, agriculture products, and a shortage of labour in construction and argiculture due to disruptions in migration. According to the most recent data, the local PPI and corporate inflationary expectations are off their peaks, but they still remain at elevated levels (Figure 4). Meanwhile, the local consumption trend has been showing relative strength even before the social handouts on growing employment and wages.

• Initially, we estimated the inflationary effect of extra social payments at 0.2-0.3 percentage points, but the sharp post-election reaction in consumer prices points at a higher sensitivity, possibly due to delayed side-effects of previous price-control measures.
• Historically, each 10% increase in Russian PPI leads to a 1 percentage point lift in local CPI with a 3-month lag (Figure 5). From that perspective the recent stabilisation in PPI is a positive sign, however its high dependence on external cost inputs is a factor of material uncertanty given the continued global pick-up in prices for freight, commodities, and finished goods.
• The government is signalling a willingness to tighten the direct fiscal spending in 2022-24 and limit local investments out of the sovereign fund at 0.6% of GDP per year, which should help contain inflation in the medium term. However, an overall fiscal consolidation does not preclude a potential increase in the social spending in case of a disappointing household income trend.
• A 1.2 percentage point jump in CPI seen in 4Q20 is creating a higher base effect for 4Q21, however a similar base effect from 9M20 did not prevent a noticeable CPI acceleration year-to-date, contrary to initial expectations.
• The recent spike in new Covid cases amid high mortality and relatively modest vaccination rate could be seen as a potential constraint to economic growth in case new lockdowns are needed, but the experience of previous mobility restrictions does not point at a definitive disinflationary effect.
• The decelerating monetary supply growth (caused by negative cash and retail deposit dynamic in the last 12 months) seems to be the only strong disinflationary factor for the foreseeable future. Historically, a 10% slowdown in the M2 growth has corresponded to a 1 percentage point decline in the CPI growth with a 12-month lag (Figure 5).