Key rate and its impact on deposits, loans, and the ruble

Key rate overview

Eight banking analysts and one economist forecast that the key rate would stay at 16 percent during the Central Bank meeting on February 16. The last meeting on December 15, 2023 saw a 100 basis point rise, marking the fifth straight increase. The Central Bank has maintained a tight monetary policy since July 21, 2023.

What exactly is the key rate

The key rate, previously known as the floor, is the minimum cost at which commercial banks obtain loans from the Central Bank and then lend to businesses and the public. This instrument forms the core of the Central Bank of Russia monetary policy framework. The rate is decided by the board of directors, which includes the Central Bank Governor and fourteen regulatory experts. The board’s five year term is approved by the State Duma, and meetings occur quarterly on a pre-set schedule.

From time to time the Central Bank may convene an extraordinary board meeting to address the rate issue, such as on February 28, 2022 when sanctions prompted rapid action. The rate rose to 20 percent per year. Although the rate was later reduced, a new cycle of increases began in mid-2023 amid elevated inflation and rising inflation expectations.

Since December 15, 2023 the baseline rate stands at 16 percent per annum. The next Board of Directors meeting regarding the rate is scheduled for February 16, with an announcement planned for 13:30 Moscow time.

Analysts have argued that there is no immediate need to raise the rate further as inflation has shown signs of stabilization. Inflation reached about 7.3 percent at the end of January 2024 after 7.5 percent at the end of November 2023, and inflation expectations among citizens have eased along with a relatively stable ruble. This view was voiced by a chief analyst leading the team at a major financial institution.

Yet the Central Bank faces inflation risks that may prevent an immediate rate cut. In a low base period during 2023, inflation could rise to around 8 percent in spring 2024. Market watchers note that the Bank is unlikely to rush a reduction and may seek a gradual slowdown in price growth over coming months.

One industry observer, a deputy chairman of the Russian Banking Association, suggested that the discussion could focus on softening the tone of policy signals or maintaining the current cautious rhetoric. Another economist from a leading investment bank agreed that no drastic move is expected in February.

Two more analysts highlighted possible scenarios that include a modest lift to 17 percent or a smaller 0.5 point increase to 16.5 percent while keeping the rate at 16 percent is also a possibility discussed by market participants. A senior official from a large commercial bank noted that the bank could consider either an uptick to 17 percent or keeping it steady at 16 percent, depending on evolving conditions.

Deputy directors at major financial institutions acknowledge that the February decision may hinge on preserving policy credibility while adjusting signals to reflect new inflation data. The central bank’s strategy might lean toward nuanced guidance rather than sharp moves.

Impact on deposits and loans

Deposit and loan costs closely track the Central Bank’s key rate. When the rate rises, loan costs tend to climb and deposit yields typically expand as banks respond to tighter monetary conditions.

How the key rate shapes deposits and loans

The higher the key rate, the more expensive loans become for both businesses and households. An economist from a prominent financial group explained that a one point rise can lead banks to adjust rates by roughly a full percentage point or a bit more. Deposit profitability also tends to rise with the key rate, and banks sometimes preemptively lift rates in anticipation of policy changes. A higher rate can dampen economic activity as borrowing costs rise, slowing business momentum and lowering efficiency in some processes.

Conversely, when the central bank lowers rates, loan and deposit rates usually fall, bond yields decline, and equities may become more attractive. The ruble exchange rate may respond as well, though such effects depend on broader economic dynamics. The economy could begin to grow again if inflation continues on a downward path.

If the rate remains at 16 percent, deposit rates are likely to stay elevated, in the 8 to 15 percent range, in the near term. Analysts expect banks to hold current pricing for now, while some advise opening deposits ahead of any revision on February 16. A two to three year horizon for deposits is suggested, as rates are expected to ease over the next few years.

Analysts also anticipate a gradual decline in deposit rates in spring 2024 if inflation continues to ease. Institutions counsel aligning saving and investment goals with personal financial needs, and timing deposits with anticipated policy moves can optimize returns. In practice, borrowers may see loan costs stabilize or decline only after clearer signs of sustained inflation relief emerge.

As expectations evolve, loan strategies may shift. Some observers advocate waiting to apply for new loans given the likelihood of lower rates later in 2024, with the first reductions potentially materializing mid-year. Savvy borrowers might consider timing loans to coincide with seasonal policy signals rather than rushing into new debt.

Financial institutions emphasize pairing deposits with flexible savings plans. The goal is to protect purchasing power while building liquidity. When choosing loans, many analysts advise focusing on real needs and the term of the borrowing rather than chasing short-term rate movements.

Ruble exchange rate outlook

Maintaining a 16 percent base rate is not expected to drastically move the ruble against the dollar or euro. Predictions place the dollar around 88 to 90 rubles and the euro around 95 to 99 rubles. The equilibrium suggests the exchange rate will remain in that vicinity after the policy decision.

Some experts believe a future rate cut could strengthen the ruble and push the dollar toward 83 to 87 rubles. A mid-2024 average around 88 rubles to the dollar is a common projection among several analysts.

Prices and inflation dynamics

Raising the policy rate tends to reduce consumer purchasing power as households save more and spend less. Demand for goods and services eases, exerting downward pressure on prices. Analysts note that price growth has already cooled under the central bank’s tight stance. If this rate holds, inflation may stay around a modest monthly pace in the coming months, with quarterly data showing slower momentum than in previous periods.

December and early January saw a marked slowdown in price growth compared with earlier months, signaling a shift in the inflation trajectory. The central bank continues to monitor price pressures and adjust expectations accordingly, aiming for stability in the broader economy.