Russia: Broad-based CPI slowdown

Russian CPI slowed from 4.3% YoY in August to 4.0% YoY in September, which was in line with the consensus forecast and slightly below our more conservative expectations. The key observation is that unlike the August slowdown, which was similar in scale but driven mostly by the volatile fruit and vegetable segment, the September deceleration was broad-based:

• Food CPI (c.38% of the CPI basket) growth slowed from 5.0% YoY to 4.6% YoY despite the acceleration of fruit and vegetable price growth from 1.3% YoY to 1.8% YoY
• Non-food CPI (c.35% of the basket) growth slid from 3.5% YoY to 3.4% YoY amid a stable 2.2% YoY growth of local gasoline prices
• Services CPI growth slowed from 4.0% YoY to 4.0% YoY.

As a result, while in the previous 3-4 months only the food segment contributed to the CPI slowdown, the September deceleration was equally distributed among the three key segments. A detailed breakdown of the CPI performance suggests that Russian inflation was pushed down by global agricultural prices, which continued to decline in annual terms, and by a strong ruble performance, which helped to bring down prices for consumer electronics and foreign travel expenses. Unlike some market participants and members of the government, we do not tend to overemphasise the role of demand constraints to CPI, as the latest Rosstat statistics indicate a recovery in local consumption and investment trends in 2Q19, while the latest confidence polls showed a marked increase in consumer confidence to 93 points in September from 90 in August and 86 at the beginning of 2019.

Given the weaker-than-expected CPI performance so far and some decline in global wheat price expectations from flat YoY to -5% YoY by the year-end, we lower our year-end inflation forecast for Russia from 4.0% YoY to 3.7% YoY, significantly below the Bank of Russia's year-end target of 4.0-4.5% forecast range.

Lower-than-expected CPI comes as one of several arguments that may weigh on the Central Bank of Russia key rate decision at the 25 October meeting.

After the 25 basis point cut to 7.00% in September:

• inflationary expectations by Russian households and corporates have improved
• downward pressure on global key rates has intensified
• the ruble exchange rate has recovered its August losses.

As a result, it is no surprise that the market has taken the recent comment by the deputy head of CBR Kseniya Yudaeva on the 'room for further cuts' as a hint of a fourth consecutive cut at the upcoming meeting.

We agree that the key rate of 7.0% has room for further cuts (we see the terminal rate at 6.5% next year), and expect the CBR to seriously consider such a move in three weeks, but expect uncertainty on this matter to persist until the last day and see several reasons why the pace of the cut cycle could be slower than the doves believe:

• Financial markets are still facing risks of increased volatility on trade tensions (10/11 October US-China talks may disappoint), global growth concerns, persisting foreign policy risks for Russia
• As the key rate has entered the neutral 6-7% range, the CBR actions should now be dictated more by the longer-term CPI trend, which is still facing risks related to upcoming acceleration in the budget spending growth from 5-6% YoY in 9M19 to 18% YoY in 4Q19, and the potential additional budget policy easing in 2020 through local investments of the National Wealth Fund, with the sum still under discussion (the initial RUB200-400bn indicative range may still be revised upwards)
• The improvement in the local demand indicators mentioned above lower the urgency to ease the monetary policy in Russia, especially given that the Russia tight control over the non-monetary CPI factors has yet to be established
• Though not necessarily the first and most important argument in favour of delayed cuts, it is worth keeping in mind that in the face of a sizeable net placement of RUB1.7tr worth of local state bonds (OFZ) planned for the next year, it would be better to start 2020 with more room for a key rate cut, rather than less room. This year's placement plan is already close to fulfillment.