Photo: A customer pays with Russian ruble banknotes at a market in Saint Petersburg, Russia July 9, 2023. Credit: REUTERS/Anton Vaganov

Russia’s Bankers Fight Inflation and the Kremlin’s War Addiction

After two years of fiscally-fueled growth and double-digit inflation, the Russian central bank is claiming a victory over galloping prices. But it’s come at a price.

By Alexander Kolyandr

July 31, 2025

The Bank of Russia cut its base rate by a substantial 200 basis points to 18% on July 25, following a 100-point reduction the previous month. It also lowered its inflation outlook for 2025 and signaled a possible further cut to bring rates to 15% by the end of the year.

Inflation has been the primary challenge for Elvira Nabiullina, the outspoken and conservative Bank of Russia governor. Despite months of pressure from politicians and industrialists, she maintained interest rates at a prohibitive 21% after the Russian government responded to Western sanctions, war needs, and labor shortages with unprecedented fiscal spending — a striking departure from its traditionally conservative budgetary policy.

This state spending, supported in part by oil revenues and higher taxes, kept the economy afloat and delivered 4.3% GDP growth in both 2023 and 2024. The downside was double-digit inflation driven by labor shortages, rising salaries, and the domestic industry’s inability to expand production.

After a protracted uphill battle, the central bank now appears to be winning its struggle against rising prices and an overheated economy. Earlier in July, it recorded inflation close to its 4% target — the first time in months the figure had been so low.

In the week leading up to the rate cut, inflation even turned negative. Average annual inflation in the second quarter fell to 4.8%, compared with 8.2% in the first quarter. This represented a significant improvement on the bank’s April prediction of 7% to 8% inflation for this year, and it updated its forecast to between 6% and 7%.

The decline was attributed to a strong ruble, which makes imports cheaper, though the labor market remains overheated. Unemployment is at a historic low of 2.2%, with demand for workers unchanged since late last year.

This labor shortage has driven rising salaries — a key factor behind high inflation. However, real wages rose just 0.1% in May, a stark contrast to 3.2% in February and 6.5% in January, and the lower growth — alongside stricter borrowing conditions — is cooling demand and dampening inflation.

“Current inflationary pressures, including underlying ones, are declining faster than previously forecast,” the Bank said after its July 25 meeting. “Domestic demand growth is slowing. The economy continues to return to a balanced growth path.”

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This “balanced growth path” is a euphemism for anemic growth. The regulator expects Russia’s economy to grow between 1% and 2% in 2025, while the IMF forecasts even lower levels of 0.9% to 1.5%.

For the Kremlin, a brief period of low growth is tolerable, though combined with lower oil prices, it would reduce fiscal revenues. The main gamble is that the cooling of the economy won’t trigger a prolonged recession.

So far, the government can maintain defense and social spending, but may need to cut elsewhere, which would put it on a dangerous path.

Reduced spending or austerity measures would further slow economic growth and wage increases at a time when sanctions, low oil prices, and challenges to property rights discourage private capital investment. Growth might not recover, even with low inflation, and military production would claim a growing share of the Russian economy.

On the other hand, if the government doesn’t reduce fiscal support, there’s a risk high inflation will return.

The Bank has made clear it still sees risks to pursuing a softer monetary policy. These include falling oil prices, geopolitical factors (specifically additional Western sanctions), and political decisions to increase spending. It said that if next year’s budget parameters differ from current agreements, it might have to reconsider its easing approach.

The Bank of Russia’s policy of high interest rates and stringent regulations, combined with external factors and economic exhaustion, has accelerated inflation’s decline, but Russia is not out of the woods.

And the Kremlin’s preference for continued spending to finance the war and support growth continues to create tension between Russia’s monetary and fiscal policy goals.

Alexander Kolyandr is a Non-Resident Senior Fellow at the Center for European Policy Analysis (CEPA) specializing in the Russian economy and politics. Previously, he was a journalist for the Wall Street Journal and a banker for Credit Suisse. He was born in Kharkiv, Ukraine, and lives in London. 

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