We think that the central bank will leave the overnight rate unchanged at 7.0% in today’s monetary policy meeting; this is in line with market expectations. We think that the central bank will relay a message of caution regarding the inflation outlook and leave the door open for potential additional interest rate increases. In our view, the bank will acknowledge that real GDP growth was stronger than expected in the second quarter, that inflation has been higher than expected due to rising agricultural prices, and that the tightness in the labor market may be causing nascent wage pressures. At the same time the bank will likely note that medium- and long-term inflation expectations are in-check. The next monetary policy meeting after today’s will take place on 28 September.

Our central scenario is that the central bank will leave the overnight rate unchanged at 7.0% in the remainder of 2017 and first half of 2018. Consumer prices rose 0.38% in July versus June, clearly above our estimate of 0.29% mom and median market expectations of 0.32% mom; in annual terms headline inflation rose to a new multi-year high of 6.4% from 6.3% in June. Core inflation was 0.27% mom, marginally above our estimate of 0.25% mom and in line with median market expectations; annual core inflation rose to 4.9% from 4.8% in June. Our estimate at the 20% level shows that annual inflation held steady at 4.8% for a third consecutive month. July’s inflation upside surprise, relative to our projections, was fueled by agricultural prices, which rose 2.5% mom, given notable price increases in red tomatoes, green tomatoes, and potatoes. In the second half of July agricultural prices rose 2.1%, compared to our estimate of 1.0%. This was the main factor accounting for the gap between our headline inflation estimate and the actual result, as core inflation results for the second half of July, as well as administered prices, were largely in line with our expectations. In the remainder of the year agricultural prices will be key in determining the inflation path.

If prices follow the seasonal pattern of the past five or six years then annual headline inflation will likely remain near 6.5% through year-end. According to our estimates, it will take some clear deflation prints in the agricultural price index in upcoming months for annual headline inflation to move much closer to 6.0% by December. For instance, if agricultural prices rise by just one-fourth of what they have risen on average in the past five years between August and December, annual inflation would still close 2017 at 6.0%. The Ministry of Labor will release today nominal wage figures for July. As a reference, nominal wage increases for the next twelve months averaged 5.2% in June, up from 4.7% in May and from 4.0% in April. This was the highest average increase since late 2009, confirming the view of some members of the central bank’s board that unit labor costs seem to be trending higher. Average wage increases were particularly high among private sector firms at 5.3%, up from 4.5% in June 2016. Wage increases in the public sector averaged 3.5%, down from 3.8% in the same period last year.