Armenian market participants` expectations indicate gradual reduction  of refinancing rate until end of current year

ArmInfo. Market expectations of the CBA policy rate path have not changed materially since the last  decision and continue to reflect expectations of a gradual reduction in the policy rate through the end of the current year.

Since the  CBA's previous policy rate decision, the yield curve has shifted  downward, while yield curve-implied expectations of the policy rate  for the next one year remain relatively elevated in comparison to  survey-based measures of policy rate expectations. This suggests the  potential for an alternative interpretation of market participants'  outlook for the economy and future directions of monetary policy.  This is noted in the message of the Central Bank of the Republic of  Armenia in the section of Monetary Policy, justifying the next  reduction in the refinancing rate to 8.25%.

Monetary Policy

The country risk premium continues to remain at relatively low  levels, partly following trends in emerging countries.  However, some  uncertainty persists regarding tensions on the state border, regional  geopolitical developments, and other factors; in this context, an  upward reappraisal of the country risk premium could pose  inflationary risks. At the same time, macroeconomic stability in  Armenia and high economic growth can serve as important preconditions  for a potential reassessment of the country risk profile.

Considering the persistence of numerous types of uncertainty, the CBA  builds and evaluates several different scenarios for future economic  developments in order to manage possible risks stemming from these  key areas of uncertainty. On the one hand, the Board has evaluated  scenarios where underlying developments would require a tighter  policy stance relative to current market expectations in order to  contain excess demand, anchor inflation expectations to the target  and guarantee the price stability objective. These types of scenarios  are primarily related to the potential for a "higher for longer"  interest rate environment in the United States, with implications on  both capital flows and the medium-term neutral rate in Armenia;  worsening geopolitical tensions, both globally and regionally;  uncertainty about the country risk premium in the context of the  fiscal deficit and geopolitical tensions; restructuring of global  supply chains; high inflation expectations; as well as other risks  and uncertainties. On the other hand, the Board also evaluated  scenarios where underlying developments would require the policy rate  to follow a more rapid and aggressive downward path than what is  currently priced in markets in order to sustainably bring inflation  back to target in the medium-term horizon. These types of scenarios  include the risk for much weaker aggregate demand conditions;  concerns about potential adverse developments in the real estate  sector; continued growth in domestic labor supply; accelerating  growth in investments, supported by the utilization of large  accumulated savings in the real sector of the economy; the potential  for a sharp slowdown in global demand; as well as other risks and  uncertainties. Given the discussion of these and other scenarios in  the context of the existing uncertainties, the Board of the CBA  emphasizes the importance of utilizing a prudent risk management  approach to ensuring the price stability objective that seeks to  minimize the losses that could stem from these scenarios  materializing. 

Domestic Demand Conditions

The growth rate of economic activity in Armenia in Q1 2024 remained  well above estimates of long-run sustainable growth (approximately  5%), comprising 14.3% Y-o-Y growth in January-March, and 15.3% Y-o-Y  in March alone.  Growth continues to be driven by strong activity in  the trade and construction sectors. In recent months, the structure  of economic growth has shifted somewhat. Specifically, manufacturing  output and exports have grown, primarily driven by sharp growth in  jewelry production. The latter could pose risks for sustained high  economic growth in the future. At the same time, the structure of  growth and concentration in some subsectors continue to raise  questions about the sustainability of similarly high growth going  forward. Information and Communication services experienced a  slowdown in output in Q1 2024, as well as a relative stabilization of  both wages and employment. Given its role in driving potential output  and export capacities, an adverse adjustment to the tech outlook  could have medium-term implications. However, there are no clear  signs as of yet of a widespread contraction.

External demand for domestic services has slowed, reflected in both  declining inflows of international tourists as well as per capita  tourist expenditures. Domestic demand continues to remain at  relatively high levels. Notably, accelerated growth in investments  has contributed meaningfully to growth in domestic demand; in the  short term, this can have some inflationary effects, though in the  medium term, growth in investments can create preconditions for  growth in the productive capacities of the economy. Growth in private  consumption has also contributed significantly to economic growth but  remains relatively subdued compared to overall income growth, as  reflected in the fact that private savings continue to remain at high  levels. The latter serves as a meaningful source of uncertainty,  particularly from the perspective of how and in which directions  accumulated private savings may be used, as well as the potential for  this to contribute to future acceleration in consumption. At the same  time, risks for additional demand pressures stemming from fiscal  policy continue to persist. The funds attracted and provided by  commercial banks continued to grow during Q1 2024, reflecting high  economic activity. CBA surveys of commercial banks further attest to  sustained high demand for loans. In recent years, the reduction in  the debt burden (relative to incomes) serves as a source of  uncertainty in terms of the potential for lending to accelerate and  generate inflationary pressures. Despite uncertainty, imbalances  between aggregate demand and supply in the economy have continued to  gradually recede.

Labor Market & Inflation

In the context of continued strong growth, labor demand and wage  growth both continued to persist at high levels, with private wage  growth standing at 8.5% Y-o-Y in February 2024. Nevertheless, the  growth in productivity and labor supply observed in prior quarters  has contributed to a weakening in inflationary pressures stemming  from the labor market. The potential for further increases in labor  supply could help ease labor market conditions, potentially  moderating inflationary pressures in the medium to long term. In this  context, the primary uncertainties relate to the potential for a  continued inflow of migrant workers to the Armenian labor market, the  rapid integration of forcibly displaced persons from Nagorno-Karabakh  in the Armenian labor market, as well as slowing flows of Armenian  labor migrants to Russia and their greater participation in the  domestic labor market.  The inflationary environment has continued to  soften, primarily driven by weakened pressures coming from the  external sector and the impacts of the CBA's policy stance over the  past several quarters. In this context, overall CPI inflation has  remained below target since April 2023, standing at -1.2% Y-o-Y in  March 2024. Non-Traded Sticky Price Inflation, which captures  domestically driven demand dynamics, continued to gradually decline,  standing at 2.4% Y-o-Y in March 2024. At the same time, inflation for  services that are highly exposed to external demand have also  continued to soften, reflecting trends of slowing demand.

Global Economy

In 2024Q1, economic activity among Armenia's main trading partners  has been mixed; however, risks of weaker economic activity going  forward continue to persist. Despite continued contractionary  monetary policy stances in the US and Russia, both economies continue  to experience high rates of growth, driven primarily by domestic  demand factors. Given continued inflationary trends in the United  States, the US Fed would be expected to continue to maintain a  contractionary policy stance, keeping rates at higher levels for  longer than what markets previously expected. On the other hand,  risks of economic contraction in the Eurozone, as well as concerns  related to the stability of the real estate market and financial  system in China, continue to remain key sources of uncertainty  driving a weaker global economic outlook. Nevertheless, economic  activity somewhat improved in both the Eurozone and China in the  first quarter of 2024.  The overall inflationary environment in the  global economy continues to weaken. Nevertheless, strong labor  markets across many countries have helped sustain high demand,  causing sticky prices to continue to remain relatively elevated.  At  the same time, heightened geopolitical tensions in the Middle East  continue to pose a risk for both higher and more volatile energy  prices as well as potential disruptions to global supply chains. In  this context, it is expected that key trading partner countries would  primarily maintain tight monetary policy conditions in the near  future. As a result, modestly deflationary effects from the external  environment on the Armenian economy would likely persist.