Week of 7/21: Sharp Russian Hikes and Unexpected Chinese Cuts

Welcome to "Worldview: Central Bank Insights" – your shortcut to understanding recent trends in global finance.

In this twenty-eighth episode, we will discuss the recent tightening of Russian key interest rates and China unexpectedly lowering their one-year policy rate, perhaps suggesting a new policy framework.

Contact: 

Email: rabossong2@gmail.com

Transcript

Hello and welcome to the 28th episode of "Worldview: Central Bank Insights”. I am your host, Reagan Bossong, a sophomore at the Wharton School of Finance, and it is my pleasure to guide you through another exploration of the largest stories regarding global financial dynamics over the past week. In today's discourse, we will begin by discussing the recent tightening of Russian key interest rates and China unexpectedly lowering their one-year policy rate, perhaps suggesting a new policy framework.

On Friday, Russia's central bank sharply increased its key interest rate by 200 basis points to 18%, the highest level in more than two years, and vowed to continue tightening monetary policy until inflation in the overheated economy subsides. The bank also raised its inflation forecast for 2024 to 6.5–7.0%, significantly above its 4% target, but expects annual price growth to decline to 4.0–4.5% in 2025. While the market anticipated this hike some voices within the Russian elite criticized the bank's approach, favoring a more dovish stance to avoid stifling economic growth. This key rate is now at its highest since April 2022, when the Bank of Russia raised rates to 20% in an emergency move shortly after Russian troops were sent into Ukraine. The central bank emphasized that to reduce inflation, monetary policy needs to be tightened further, with the next rate-setting meeting scheduled for September 13. Annual inflation, the bank's main concern, rose to 9.0% as of July 22, up from 8.6% in June, compared to 7.4% in 2023 and 11.9% in 2022. The central bank stated that returning inflation to the target requires considerably tighter monetary conditions than previously assumed and will consider further key rate increases at upcoming meetings. Central bank governor Elvira Nabiullina described the economy as "substantially overheated" and noted a broad consensus among board members for the rate decision, with some suggesting an even larger hike. She expected monthly inflation rates to start decreasing in July, but achieving a sustainable decline in price growth would take longer, noting that the central bank had underestimated the impact of budget spending on inflation in the first half of the year. Just before the rate announcement, the Kremlin acknowledged "various views regarding the overheating of the economy" and affirmed that "necessary measures are being taken.” The Bank of Russia has raised rates by 850 basis points in the second half of 2023, including an unscheduled emergency hike in August as the ruble tumbled past 100 to the dollar, and the Kremlin called for tighter monetary policy.

Next, the People’s Bank of China (PBOC) unexpectedly reduced the cost of its one-year policy loans by the most significant margin since April 2020, just days after cutting a key short-term rate, signaling increased support for the slowing economy. On Thursday, the central bank decreased the rate of the medium-term lending facility (MLF) by 20 basis points to 2.3%, marking the first reduction in almost a year. This cut followed the PBOC’s earlier trim of the seven-day reverse repo rate by 10 basis points on Monday. The PBOC's sequence of rate cuts underscores the authorities' urgency to support growth, which fell below expectations in the second quarter due to faltering consumer spending, despite an export boom. The central bank had avoided cutting rates since late last year to keep the yuan exchange rate stable. The announcement was unexpected, as the PBOC typically conducts MLF operations in the middle of each month and had already drained a net 3 billion yuan ($413 million) of cash via funds earlier this month when a batch of them matured. On Thursday, the PBOC provided 200 billion yuan of MLF, the biggest net injection since January. This sequence of rate cuts and the off-schedule MLF operation reflect the PBOC's transition toward a new framework. By making the seven-day reverse repo the main policy lever that guides lending and longer-term rates, the PBOC could send a clearer signal and better influence the market. Along with the new tool of government bond trading, this shift could potentially give the central bank more sway over borrowing costs from short to long-term durations. However, economists believe that these cuts will have a limited impact on boosting domestic demand without any improvement in the overall jobs market. The MLF remains high both in absolute terms and relative to the seven-day reverse repo, as market rates have decreased and the spread between short- and longer-term borrowing costs has narrowed. Banks have shown little appetite for MLF funds in recent months, as declining market rates have made it cheaper for them to borrow from each other rather than from the PBOC via the program. The surprise announcement of the rate cut also risks introducing more confusion over the PBOC's policy schedule, as it is now unclear whether MLF operations will take place on the 25th of each month instead of the 15th. This change could make it harder for banks to manage liquidity, as existing MLF funds would still mature around the 15th. The latest cut followed China's largest state banks lowering rates on some deposit products to ease pressure on profit margins after their earlier cuts to the benchmark lending rates, known as the loan prime rates. 

So yeah, in conclusion, we began by discussing the recent tightening of Russian key interest rates and China unexpectedly lowering their one-year policy rate, perhaps suggesting a new policy framework.. That’s a wrap for this week's central bank roundup. If you have topics you want me to dive into or thoughts on today's podcast, let me know anytime. You'll find all my contact details in the show notes. Until next time. Thank you!