Russia Monetary Policy

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Russia: Bank Rossii unexpectedly raises repo rate, still sees inflation above target

June 25, 2014

At its 25 July meeting, Bank Rossii raised the one-week repo rate to 8.00%. The move took market analysts by surprise, as they had expected the rate to remain at 7.50%. As in previous months, the Bank acknowledged that the inflation target would not likely be met in 2014 and emphasized the role of political instability in pushing up inflation expectations. The next meeting is scheduled for 12 September.

Regarding the performance of the domestic economy, Bank Rossii continued to point to structural factors as the main cause of sluggish economic growth. According to its own estimates, the Bank sees the economy showing flat quarter-on-quarter growth in Q2 following the contraction tallied in Q1. The Bank also said that a “moderate recovery” has been observed. Nevertheless, the ongoing political instability is expected to drag on the Russian economy, especially due to low business confidence and limited access to long-term financing. At the international level, the Bank said that, despite the fact that high oil prices continue to support the Russian economy, slack in Russia’s economic partners is not supportive of external demand.

The Bank was more worried about the evolution of inflation than about the situation in the real economy. Annual inflation came in at 7.8% in June and the Bank expects consumer prices to ease somewhat in July. As in previous meetings, the Bank reckoned that the 4.0% inflation target will not be met in 2014. However, it sees inflation of between 6.0% and 6.5% by the end of this year, and expects it to converge at the 4.0% target in the medium term. That said, the Bank expects inflation to ease progressively in the remaining two quarters of 2014. This will be mainly due to a more stable ruble (see FX chart), a likely good harvest, subdued aggregate demand for goods and services at the domestic level, and a lower scale of increase in administered prices and tariffs.

Given the recent developments in the international political arena and several tragic events that have increased instability in the region, some analysts have made a political interpretation of the Bank’s unexpected rate hike. The possibility that there will be new and stronger sanctions for Russia is becoming more likely and thus the Bank’s move can be interpreted as preventive in order to contain negative impacts of the sanctions. An alternative view is one that gives more weight to inflationary pressures in the Bank’s decision-making process. According to Anatoliy Shal, economist at JP Morgan:

“Interestingly, while the CBR’s bold action this year—with a cumulative 200bp in hikes—has solidified credibility in the markets, this latest hike, could be a step too far and appears riskier to us. The economic outlook is already downbeat and if Russia falls into recession in the coming quarters, the hawkish CBR may be accused of tightening its talons too much.”

Finally, it is noteworthy that the Bank acknowledged that the exchange rate of the ruble (RUB) has gained stability in recent months, and, according to the Bank’s rhetoric, it is no longer a major concern. The Bank has not altered its intervention bands since early May. For the last two months, the ruble has been stable around the 40 RUB per USD+EUR basket that the Bank uses as reference. Increased stability in the exchange rate of the ruble and the interest rate hikes have also had an effect on capital outflows. In the second quarter, capital outflows amounted USD 25.8 billion, which was markedly down from the USD 48.8 billion flight seen in the first quarter. That said, the outlook for the exchange rate and capital outflows is expected to be highly conditioned by the scope and strength of the potential sanctions that the U.S. and the EU may put on Russia.

Against this backdrop, FocusEconomics Consensus Forecast panelists expect the refinancing rate to close 2014 at 7.21%. For 2015, the panel expects the rate to end the year at 6.28%.


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