Interest Rates Dropped to 17%: Three Reasons for the Russian Central Bank's Cautious Stance
The economy is in uncertainty, and the ruble has lost its optimistic support. What will happen next?
The Russian Central Bank (referred to as "the Bank") has lowered the key interest rate to 17%. There is great uncertainty about the future direction of this rate. It is expected that by October, we may see a "hawkish" revision of economic forecasts.
Market participants and most analysts had previously expected a more significant reduction in the interest rate — a decrease of 2 percentage points to 16%.
This expectation arose because, at the July meeting of the Central Bank Board, the key interest rate was reduced by 2 percentage points in one go; additionally, the macroeconomic forecast released after the meeting indicated a very optimistic path for the interest rate in the coming months — a reduction of 2 percentage points in September, and 1 percentage point each in October and December. According to this expectation, the key interest rate could be reduced to 14% by year-end. Moreover, given the current favorable inflation situation, the market believed that the Central Bank would reduce the interest rate as quickly as possible.
Therefore, this decision by the Central Bank triggered a sell-off in the Russian stock and government bond markets: the Moscow Stock Exchange index fell nearly 2.4% on the same day. However, in fact, this decision was not unexpected and made sense. We had previously predicted that the interest rate would drop to 17%.
Additionally, we had also mentioned before that "even if the Central Bank kept the key interest rate at 18%, we would not be surprised." This prediction was also close to reality: Central Bank Governor Elvira Nabiullina stated that during the meeting, two options were discussed: reducing the key interest rate to 17% or keeping it at 18%; the option of reducing it to 16% was never considered at all.
In general, the Governor's statements at the press conference were quite firm: inflationary pressures remain dominant, and it is not yet clear whether further rate cuts will occur, with subsequent decisions depending on the latest economic data.
Nabiullina's reasons for "adopting a more cautious monetary easing approach" are broadly consistent with our recent reports, which include: accelerated credit growth, rising inflation expectations, and an expanding federal budget deficit.
Perhaps the only major difference between our assessment of the current situation and what the Central Bank described lies in the fact that although the Central Bank also mentioned the "volatility of the ruble exchange rate" before the meeting (which was actually the depreciation of the ruble), it did not consider it an important driver of inflation and did not focus on it.
There is a formal reason behind this: according to the Central Bank's own regulations, it cannot publicly announce predictions about the ruble exchange rate, meaning it cannot mention the potential impact of a significant depreciation that has not yet occurred.
However, unlike the Central Bank, we are not restricted by such regulations, so we are willing to share our prediction: the ruble depreciation will continue, and it will be quite rapid.
Within the next few months, we may see the dollar-to-ruble exchange rate break through 90 to 1. It is worth noting that almost all analysts and market participants expect a similar situation.
Why are we so certain that the ruble will weaken in the future? Because until recently, high interest rates have been supporting the ruble exchange rate, even when everyone knew that the local currency was overvalued, this support was still effective.
After all, people could obtain returns of 20% or higher with minimal risk by investing in ruble assets (through bank deposits or money market funds).
In other words, before the start of the rate-cutting cycle, the yield on ruble assets exceeded the potential depreciation gains from holding foreign currency.
Specifically, in a high-interest-rate environment, exporters sold foreign exchange income exceeding the required amount. It should be noted that as of mid-August, major Russian exporters had to remit at least 40% of their foreign trade revenue and sell at least 90% of the foreign exchange domestically.
In mid-August, the government abolished the mandatory foreign exchange sales requirement, citing the reason that the regulation had become meaningless because exporters were already selling far more foreign exchange than required.
But the government deliberately concealed a fact: the increase in the amount of foreign exchange sold by exporters was driven by previous high interest rates, and the high-interest-rate era is now a thing of the past. We should not assume that the government cabinet is truly unaware of this; in fact, the government is influenced by lobbying groups and intentionally promotes a weaker ruble to increase federal budget revenues.
Now, the situation facing the domestic currency has changed: on one hand, the yield on risk-free ruble assets has significantly declined; on the other hand, the mandatory foreign exchange sales requirement for exporters has been completely abolished.
These two factors combined will lead to a significant reduction in the amount of foreign exchange sold by exporters — a factor of great importance for Russia's "sensitive" foreign exchange market. We have already seen the beginning of this trend in the August data.
Additionally, after importers adapted to the sanctions measures implemented last winter for cross-border settlements, and with the decline in interest rates stimulating consumer demand, the scale of imports in Russia has started to grow.
It is worth noting that the events of last week exactly confirmed the importance of interest rates on exchange rates. Affected by negative geopolitical news and market optimism about the key interest rate dropping to 16%, the ruble depreciated: the dollar-to-ruble exchange rate rose from 1 to 81 to 1 to 85 within four days, from Monday to Thursday (reaching as high as 1 to 85.8 at one point).
However, after the Central Bank announced a more moderate rate-cutting approach, the ruble recovered most of its losses, and by Friday, the dollar-to-ruble exchange rate had risen 2.5% to 1 to 83.3. By the closing of the market on Monday, September 15, the exchange rate further rose to 1 to 82.2.
The September Central Bank meeting was an intermediate meeting, meaning that no updated macroeconomic forecasts (or predictions about the future trajectory of the key interest rate) were issued after the meeting. The forecasts issued after the July key meeting are still valid.
As we know, that forecast was made under an extremely optimistic background regarding the "decisive victory over inflation." Since then, the situation has changed, previous trends have been broken, and new trends are still forming, currently unclear.
Under the increasing uncertainty, the Central Bank chose to delay major actions and maintained the maximum caution. The interest rate was indeed reduced; maintaining the rate at 18% during a period of high market optimism could have caused market shocks. However, the extent of the rate cut has been reduced to the minimum feasible range — because at the current relatively high interest rate level, the Central Bank typically does not make cuts of less than 1 percentage point, nor does it use decimal adjustments.
Major decisions have effectively been postponed to the October key meeting, where the Central Bank will update the macroeconomic forecasts. Especially by the end of October, the Central Bank will have more clear information on key issues, providing a basis for decision-making.
First, the trend of credit growth will become clearer: whether credit has entered a phase of rapid growth (data from July and real-time data from August show signs of this). Second, the speed of ruble depreciation will become evident. Third, the status of the federal budget deficit will become clearer — this issue has the highest uncertainty. Regarding the last point, it is necessary to elaborate.
We have reported on the significant expansion of the federal budget deficit in July. Now let's look at the performance of the federal budget in August. At first glance, the situation seems unproblematic: the federal budget achieved a surplus of 686 billion rubles in August.
However, in fact, the August budget surplus was the result of seasonal factors. Every August (the last month of summer), budget expenditures are usually the lowest throughout the year, while revenues are relatively high — because the State Bank and state-owned enterprises pay dividends to the treasury. It is worth noting that the federal budget surplus in August 2024 was much higher than this year, reaching 1.071 trillion rubles.
Comparing the expenditure figures, the situation is similarly concerning. Federal budget expenditures in August 2025 increased by 23.2% compared to the same period in 2024, a significant increase, much higher than the inflation rate.
Comparing the expenditures for the first eight months of this year with the same period in 2024, the situation is similar: expenditures increased by 21.1%.
It should be noted that the current version of the federal budget law sets an annual expenditure increase of only 5.3% (compared to 2024). To achieve the expenditure target, budget expenditures need to decrease by 16% compared to the same period in 2024 in the remaining four months of this year (this data comes from the estimates of the MMI Telegram channel).
And this 16% decrease is nominal; considering inflation, the actual decrease would be much larger. Such a significant reduction in spending is practically impossible to achieve in reality, which means the size of the federal budget deficit will definitely be significantly increased.
This budget adjustment will take place at the end of September, when the government will submit the 2026 budget draft. That is to say, by the time the next Central Bank meeting takes place, the Central Bank will have information that the federal budget deficit is much higher than expected. This factor is an important driver of inflation, and the Central Bank will inevitably take it into account when formulating the updated macroeconomic forecasts.
Therefore, it is highly likely that the Central Bank will suspend the rate-cutting cycle at the October meeting. Additionally, the prediction for the future trajectory of the key interest rate will certainly be more "hawkish" than the July forecast, which is still officially valid. The scenario previously expected by the Russian financial system — "reducing the key interest rate to 14% by the end of the year" (which still existed before the September Central Bank meeting) — is likely to be put on hold.
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