(Bloomberg) -- The Bank of Russia has held its benchmark interest rate for more than five months at the highest level since early in the country’s war on Ukraine, believing it could start easing later this year. Inflation data may be putting those plans on ice. 

An acceleration in price growth in recent weeks caught the central bank off guard, people familiar with the discussions said, asking not to be identified as they weren’t authorized to speak to the media. It’s now unclear if policymakers will be able to loosen monetary policy before the year’s end, and they may even have to tighten it further, the people said.

The bank had been confident that holding the key rate at 16%, the highest since April 2022, but still lower than the 20% levels immediately following the invasion, was sufficient to start moving inflation back toward its 4% target. 

Still, annual price growth rose to 7.84% in April from 7.72% in March, while weekly data for May show it was continuing to accelerate. Inflation expectations among the population also rose to 11.7% in May from 11% in April, according to a central bank survey. Inflation increased 0.1% in the week from May 21 through 27, according to Federal Statistics Service data released late Wednesday. 

Before its April rate meeting, the central bank’s leadership believed changes in consumer prices signaled weakening inflation, and debated whether that trend would continue, given other factors like a tight labor market and robust investment activity, according to a summary of the key rate discussion.

The April inflation data released after that meeting showed, however, that price growth remained high. The figures cast doubt on the central bank’s April forecast that price growth would reach 4.3%-4.8% at the end of 2024. 

What Bloomberg Economics Says...

“The government’s spending surge is the main obstacle for the Bank of Russia to bring down inflation. Widespread, government-funded interest-rate subsidies blunted the central bank’s benchmark rate hikes, and left the cost of borrowing low for most households and corporations. Consumers are also undeterred by high rates as competition for labor between the private sector and the military means wages are soaring and employment remains secure. We expect inflation will peak in May at 8.2% year-on-year and settle on a course to 5.7% for the full 2024.”

— Alex Isakov, Russia economist

Bank of Russia Deputy Governor Alexey Zabotkin since then has compared the economy to an overheating car. 

“It’s impossible to ‘squeeze’ more out of the economy than it’s capable of giving in its current state,” Zabotkin told the Argumenty i Fakty newspaper. “It’s like continuing to press on the gas when the engine is already at maximum speed and the car is going up a steep hill. The engine will boil, you will stop. And worse, you risk falling back.”

Zabotkin also told reporters last week that the central bank would consider the option of raising rates at its June meeting, as recent economic data strengthens the case for keeping monetary policy tight, the Interfax news service reported. He has also said that changes to the rate take 3-6 quarters to affect the economy, and Russia’s benchmark has only been at 15% or higher since the end of October. 

“Strong economic growth is a surprise to everyone, and this fuels inflation and inflation expectations,” said Dmitry Polevoy, investment director at the Moscow-based Astra Asset Management.

Read more: Russia’s War Fuels a Wage Spiral That Threatens Army Recruitment

The central bank believes a variety of factors are driving accelerating inflation. Some, like the tight labor market, increased wage competition, state spending on defense and preferential lending programs, are internal. But external factors like higher energy and food prices due to supply chain disruptions also contribute, the bank said in its six-month Financial Stability Review.

President Vladimir Putin in April tried to quell business lobby concerns about the impact of high lending rates, saying he sees “positive trends, downward,” while also cautioning, the threat of inflation “still hangs over us.”

Gross domestic product expanded 5.4% year-on-year in the first quarter, almost a percentage point higher than the central bank’s estimate. Regulators see growth in the fourth quarter slowing to 0.5%-1.5%.

“Tight monetary policy should work to cool domestic demand,” said Olga Belenkaya, an economist at Finam in Moscow. “But this is not very effective, since a significant part of this demand is weakly dependent on interest rates,” and there are still many inflation risks ahead.

(Updates with weekly inflation data in the fourth paragraph.)

©2024 Bloomberg L.P.