On parameters of the interest rate corridor

28-03-2024

28 March 2024, Baku: The Management Board of the Central Bank of the Republic of Azerbaijan decided to decrease the refinancing rate to 7.5% from 7.75%, the ceiling of the interest rate corridor to 8.5% from 8.75% and leave the floor of the interest rate corridor unchanged at 6.25%.

This decision was taken in consideration of the comparison of the actual and forecasted inflation with the target (4±2%), the stabilization of inflation expectations and changes in the balance of risks. Considering that the forecasted inflation remains in the target, the aim of decreasing the ceiling of the interest rate corridor and the refinancing rate is to ease the monetary condition. The floor was left unchanged to optimize the width of the interest rate corridor. While determining the parameters of the interest rate corridor the magnitude of impact of these rates on interest rates in the interbank money market was also considered.

Annual inflation rate has been declining since the last meeting. In February 2024 twelve-month inflation stood at 0.8% and twelve-month core inflation stood at 1.4%. Annual food deflation was 0.3%, non-food inflation was 1.4% and services inflation was 2.3%.

Annual inflation decreased due to the influence of both external and internal factors. According to the World Bank, the commodity price index fell by 7.3% and energy prices fell by 7.5% in February 2024 on an annual basis. According to the US EIA, the forecast of an increase in oil reserves from Q2 2024 will be one of the main factors to weigh on prices. The UN FAO reported 10.5% drop in the food price index in February on an annual basis. The appreciation of the nominal effective exchange rate of the manat (19.3% in 2023 and 1.8% over 2 months of 2024) provided additional contribution to imported inflation. 

The FX market has been in equilibrium since the beginning of 2024. Over the past period of the year demand for foreign exchange was higher at several currency auctions arranged by the Central Bank due to the expansion of import financing, attributable to public investments and the activation of private sector consumption. Over 2 months of 2024 non-oil and gas investments y.o.y. increased by 17.1%, a significant part of which was financed from internal sources; it was accompanied with higher downpayments associated with the non-oil and gas export. The above confirms the rise in demand for foreign currency originated from imports.  In general, the FX market is operating on the backdrop of the balance of payments surplus. The current account surplus of the balance of payments amounted to 11.5% of GDP in 2023. The trade surplus made $2.3B over 2 months of 2024. Forecasts indicate that, if current trends persist, the current account will be in surplus ($7-8B – the January forecast) in 2024 as well. Furthermore, the ongoing drop in dollarization of deposits in February suggests that confidence in the manat is maintained as a savings facility. Thus, in February dollarization of deposits of legal entities and individuals (excluding the financial sector) was down by 1.3 pp compared with January and by 9 pp year-over-year. 

Monetary policy tools contribute to the neutralization of effects of autonomous factors on the monetary condition. Open market operations and the active use of standing facilities allowed the weighted average of interest rates on both manat denominated unsecured and secured deals between banks in the money market to move within the interest rate corridor of the Central Bank. Over the past period of March, the average interest rate on one-day unsecured deals (1D AZIR) was 6.52% (6.29% in February), which is within the interest rate corridor. Reforms continued to amplify the effect of interest rates in the money market on other interest rates, including deposit and credit rates.

There has been no significant change in the risk balance of inflation since the last meeting. The main inflationary risks of external origin include persistent geopolitical tensions, impediments in the critical international trade routes, as well as climate changes, which are likely to make global commodity prices and inflation in partner countries more volatile. Activated cost factors may act as the main internal risk to push inflation. Fiscal operations are not ruled out to have an increasing effect on money supply in the current year.

In general, upside and downside risks of inflation balance each other. The inflation forecasts for 2024 were left unchanged (January forecast: 5.3%). If current conditions remain unchanged, in 2024 annual inflation is expected to remain within the target band (4±2%). Analyses suggest that, over the remaining part of the year the annual inflation forecast may be revised down.  

Next decisions related to monetary easing will depend on how persistent the downward trend of inflation is and on the dynamics of supply and demand factors of external and internal origin. If the said risks materialize, the Central Bank may consider options to take a pause in monetary easing over the remaining period of the year. The macroeconomic indicators and transmission of interest rate corridor parameters to interest rates will be monitored in the upcoming period.

This decision will take effect on 29 March 2024. The information on the next decision on interest rate corridor parameters will be made public on 1 May 2024 accompanied with a related press-conference.