Bank of Russia slows rate cuts, sends signal to government

The Central Bank reduced its base rate on Friday by 25 basis points to 14.25%. It was the ninth successive cut, but the smallest possible reduction. Amid public pressure from Putin, who last week used inflation figures to publicly push to cut rates faster, this looks like a compromise. The bank is continuing with its easing cycle, but made it clear there isn’t much more room for maneuver due to the government’s high spending.

• The formal grounds for cutting rates remain. Price increases in April and May slowed to 2.1% year-on-year after 8.7% in the first quarter, the bank reported in its press release. Core inflation fell from 6.2% to 4.2%. On June 15, annual inflation was 5.6%, lower than a month earlier. Inflation expectations also fell, although they remain high among both business and the general public. After a poor first quarter that saw the economy slightly decline, it is now starting to recover: consumer demand is picking up and investment activity increased slightly. The Central Bank described the growth as “moderate”.
• The main obstacle to lowering interest rates is state spending. The Central Bank stated starkly that fiscal policy “will stimulate more than anticipated over the next three years” and that “could require a higher base rate trajectory than was assumed in April’s base scenario.” In addition, the bank is concerned about rising yields on mid-to-long term government bonds. This is not due to tighter monetary conditions, but the “uncertainty of future budget projections”. In other words, the market does not trust the government’s budget discipline. It seems that budget parameters for 2026 and 2027 are still unknown — not just to the public, but even to the Central Bank.
• Cutting through the jargon, this all means that the government is spending more than it promised. The Central Bank is warning that it will apply austerity policies to compensate. You can read more about the finance ministry’s plans to borrow above its limits here. 

Why the world should care

The Central Bank offered Putin and business a symbolic cut of 0.25 percentage points. That won’t change borrowing costs for business, nor affect demand dynamics. But, at the same time, it makes it very clear that the real risk of inflation comes not from interest rates but from the state budget. The Central Bank is essentially telling the government it can demand lower interest rates, but while it splurges on the war, a strict monetary policy needs to stay in force.