Russia: Central Bank hikes interest rate amid escalating inflation
October 31, 2014
Escalating inflationary risks and a plummeting currency prompted Bank Rossii to decide hiking the one-week repurchase rate from 8.00% to 9.50% at its 31 October meeting. Although most analysts had foreseen an increase at this meeting, the Bank’s decision to raise the rate by 150 basis points took them by surprise, as most analysts had expected a 50-basis-point increase.
In its statement, the Bank recognized that significant changes in external conditions took place in September and October (a considerable drop in oil prices and stricter sanctions imposed by the West), which prompted the ruble to fall sharply and food prices to increase notably during the period. As a result, inflation grew more rapidly than expected in September and, consequently, inflation expectations among Russian consumers and businesses continued to increase, aggregating additional pressure on consumer prices. Consequently, the Central bank went on to recognize that it expects inflation to stay above 8.0% through the end of 2014 and beginning of 2015.
Regarding the country’s economic performance, the Bank estimated that economic activity weakened in the third quarter to a 0.2% increase (Q2: +0.8% year-on-year). The Bank pointed out that, “besides structural factors, increased external political uncertainty has an adverse impact on economic activity. Amid limited access to long-term financing and higher borrower requirements from Russian banks, fixed capital investments are contracting.” Simultaneously, private consumption is cooling as wages—in real terms—continued on a downward trend. The Bank underlined that adverse external conditions, such as the fall in oil prices and weak demand from Russia’s main trading partners, are having a negative impact on the country’s exports.
Going forward, the Bank stressed that high inflation is likely to persist until the end of Q1 2015. For the remaining quarters of 2015, Bank Rossii acknowledged that, once the economy adjusts gradually to external conditions, inflation and inflation expectations are foreseen falling. The next monetary policy meeting is scheduled for 11 December.
Under the current framework, Russia’s Central Bank is on its way to completing the transition toward the free-floating exchange rate and inflation targeting regime by the end of this year. However, against the backdrop of a sharp depreciation of the ruble seen in the past two months, the Bank resumed its intervention in the currency market in October as the bi-currency basket continuously exceeded the upper boundary of the floating operational band. Many analysts agree that if the Bank remains committed to completing the transition at the end of this year, it might make sense to abandon interventions ahead of schedule in order to preserve foreign exchange reserves.
Author: Ricardo Aceves, Senior Economist