The Central Bank of Russia announced that the neutral rate will be increased in July, which may have long-lasting consequences for the OFZ market. We believe this implies more hawkish monetary policy in the medium-term. Investors should be ready for rates to remain high and the probability of monetary easing in 2024-25 has decreased. Under this scenario, it is most likely that the yields of long-term securities will remain within 10-10.5% per annum until end-2023, while short-term securities may see pressure as the key rate is increased towards 8% per annum.
Inflation remains low, demand on the rise. For the fourth time in a row, the CBR kept the key rate unchanged at 7.5%. With inflationary pressure in the economy unusually low, the CBR has no strong argument to hike the rate for now. However, high frequency data shows an improvement in demand which may translate into price growth in the future. In March, the CBR’s business climate indicator approached the level of 2Q21 and many manufacturers are seeing the highest demand since 2017.
CBR announces that the neutral rate will be increased in July. At its latest meeting, the CBR announced that it would increase the neutral rate in July. The regulator said that the hike is driven largely by three factors: fiscal policy (structural budget deficit); the Russian economy’s risk premium; and the level of foreign risk-free interest rates. We highlight another important factor – the narrowing of the output gap, which will increase from -3.6% in 2022 to -0.3% in 2023-25 on average. We believe that the revision of the neutral rate indicates that monetary policy will remain more hawkish in the medium-term. Investors should be ready for rates to remain high. The probability of monetary easing in 2024-25 has decreased and the official average key rate trajectory may be shifted upward in the coming months.
Inflation to drop below 4% due to base effects, key rate to rise to 8%. In the coming months, annual inflation will temporarily drop below 4% due to the high base effect of last year. We believe that inflationary pressures will gradually increase from moderately low levels. We now expect inflation to reach the upper bound of the CBR’s range in the year-end (close to 7%). To keep inflation within the CBR’s range of 5-7% for 2023, we believe the key rate will be hiked to 8% at least. Meanwhile, the current key rate trajectory shows a downward trend in key rate in 2023-25 – a negative slope in 2023-25 is an important indicator for the OFZ market.
No way down for OFZ yields yet. We see no room for a decrease in long-term bond yields in the current environment and we expect them to remain near current levels in the medium-term. With growing risks of a key rate hike and pressure from placements of long-term OFZ at premiums to the secondary market, yields of long-term securities are likely to remain within 10-10.5% per annum until end-2023, while short-term securities may see pressure as the key rate is increased towards 8% per annum.