A more moderate pace of lowering the base rate

Elmira ArnabekovaAugust 22, 2017

Yesterday, the National Bank decided to decrease the base rate to 10.25% with the corridor of +/-1pp. The reduction step was changed to a more moderate one, to 0.25pp. The monetary policy easing was driven by the continued slowdown in the level of annual inflation (to 7.1% in July), a stabilization in commodity markets, an expected decline in inflation in the medium term (according to the NBK forecasts) and a stable level of inflationary expectations.

Annual inflation in July slowed to 7.1% as a result of lower food prices, seasonally-adjusted price increase also showed deceleration. In the coming months, in view of the high base of last year, a slight increase in inflation rate is expected, which, in the regulator's opinion, will not require the application of corrective measures by the monetary policy.

It should be noted that the impact of the base rate on the activation of economic growth is limited, in view of the fact that demand for loans remains depressed, which is why the reduction of rates in the money market does not yet contribute to a sustainable growth in lending. The country's economy is being restored entirely by the extractive sector. In our opinion, the restoration of consumption will be the main driver for achieving long-term growth potential of the economy. Currently, the dynamics of real money income (in January-June, a decrease of 3.4% yoy), and real wages (in January-June, -2.4% yoy) in the first half of this year is still in the negative zone. Since the beginning of the year, the regulator has lowered the base rate by 1.75pp, from 12 to 10.25%, but the effect of lowering rates on lending stimulation and consumption growth is still weakly visible (in June, the credit to economy decreased by 0.22% since the beginning of the year, taking into account the adjustment for the exchange rate).

Banks continue to allocate available funds on NBK instruments: the volume of gross withdrawn liquidity by the regulator was T3.7 trillion by July. Lower interest rates decrease the cost of funding, but also limit the profitability of the banking sector.

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Our opinion

This decision is in line with our expectations. Given the deceleration of inflation in July while external risks maintained, the regulator became more cautious regarding its monetary policy easing, with a decrease in the pace of base rate reduction to a quarter of a percent. It is observed that the yield curve for the placement of short-term notes has a negative slope, as though the participants of the money market expect a decrease in the base rate in the horizon of the next 12 months.

We note that there are risks of inflation acceleration through the exchange rate due to external risks (geopolitics, oil prices drop). In these conditions, to protect the exchange rate and prevent speculation, a reduction in rates in the money market is not permissible. Apparently, therefore, the regulator indicated its intention to review the prospects for further lowering the base rate in the short term. In the absence of external shocks, and a sustained slowdown in the rate of inflation, we expect the base rate to decline to 10% by the end of the year. The next NBK decision on the base rate will be held in early October.