Expectedly, the tight monetary policy of the Central Bank of Russia and correction of oil prices allowed the ruble to win back a part of its lost value after the collapse in early 2016. But, in my opinion, further interest rate retention at the current, relatively high level brings the risk of further contraction in already dangerously low business activity. Therefore, most likely, in April, the Central Bank of Russia will agree to the rate cut, which will create momentum for a weakening of the ruble.
Before focusing on Russian monetary policy, I wish to emphasize that the current level of the ruble already looks to be overbought against the background of current oil prices.
Based on the model of statistical dependence of the USD/RUB currency pair on the barrel price of Brent crude oil, at the beginning of April we fix the deviation of the current USD/RUB price by 4 rubles from the balanced level.
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The Central Bank of Russia has held interest rates at 11% since August 2015. The devaluation of the ruble as a consequence of the drop in oil prices from October 2015 to January 2016 impacted the growth of inflation and inflation expectations. In the periods of the maximum volatility of the ruble exchange rate in December 2015 the Central Bank resorted to the restraint of the ruble REPO auction limits that allowed to stimulate the demand for ruble within the financial system, without increasing interest rates. As a result, the inflation situation stabilized — relatively speaking. According to the statistics service of Russia, inflation in March 2016 amounted to 0.5% m/m (0.6% m/m in February 2016) and 7.3% y/y (8.1% y/y in February 2016). This was due partly to the fact that the real incomes of the Russian citizens has been declining continuously since November 2014. This results in falling effective demand and retail turnover.
Besides inflation, another key parameter for the Central Bank in determining the course of the monetary policy are inflationary expectations. According to the Bank of Russia estimates as of March 2016, the inflationary expectations for the next 12 months has fallen, though they still remain at elevated levels. Note, however, that inflation expectations have already returned to the values corresponding to the periods of declining interest rate in 2015 (February, March, May, June).
Another situation capable of inducing the Central Bank to lower the interest rate in April is the increasing negative effects of long-term tight monetary policy. According to Markit data, the PMI index of the manufacturing industry in Russia in March 2016 dropped to 48.3, versus 49.3 in the previous month. This is the lowest PMI over the past 7 months. It is obvious that the economy needs a positive impulse, even at the cost of depreciation of the national currency.
Based on current budget of Russia, the oil barrel price expressed in rubles is 3150 rubles. The current actual rate is much lower. If you do not consider the forecast that oil prices could soon rise above $46 per barrel, in order to reduce the budget deficit, the Central Bank is not interested in further strengthening the ruble, certainly not at the cost of tight monetary policy.
I believe that, at the April meeting of the Russian Central Bank, an interest rate reduction to 0.5 or 1 percent will be decided upon. As a result, the currency pair USD/RUB will grow to the level of 71-73 rubles in the forecast time frame of 1 month.
Unless otherwise noted, all charts included are my own.
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