Russia’s central bank unexpectedly hiked its key interest rate by 350 basis points to 12% on Tuesday, an emergency move to try and halt the rouble’s recent plunge after a public call from the Kremlin for tighter monetary policy.
This was the second straight increase and the sharpest since the start of the Ukraine war almost 18 months ago. The emergency meeting came after the rouble tumbled past the 100 thresholds against the dollar on Monday, dragged down by the impact of Western sanctions on Russia’s balance of trade and as military spending soars.
The rouble pared gains after the decision to stand 0.5% weaker at 98.16, but still significantly above lows near 102 on Monday which had not been hit since the early weeks after Russia invaded Ukraine.
On Monday, President Vladimir Putin’s economic adviser Maxim Oreshkin rebuked the central bank, blaming what he called its soft monetary policy for weakening the rouble. Hours after Oreshkin’s words, the bank announced the emergency meeting, throwing the currency a lifeline.
The accompanying Bank of Russia statement was considerably shorter than previous ones. Unlike in the press release after the last meeting, the Bank refrained from including the usual hawkish phrase that “the Bank of Russia holds open the prospect of a further increase at its next meeting”, suggesting that today’s outsized hike is at least partially front-loading the hiking cycle that we and consensus had expected, and leading some analysts to speculate that interest rates had peaked.
“Inflationary pressure is building up,” the bank said in the statement adding that “the pass-through of the rouble’s depreciation to prices is gaining momentum and inflation expectations are on the rise.”
But a little after the decision, the bank issued an additional statement: “In the case of strengthening pro-inflationary risks, an additional increase in the key rate is possible.”
The Bank continues to see inflationary pressure building and puts inflation momentum and core inflation momentum in the 3 months to 7 August at 7.6% and 7.1% respectively, well above the 4% target. Similar to the previous statement, the Bank attributes the price pressure to “steady domestic demand surpassing the capacity to expand output” and, unlike in the previous statement, it explicitly links strong domestic demand to the recent depreciation of the Ruble through its positive impact on import growth.
Commenting on the decision, Goldman analyst Clemens Grafe writes that “the Bank’s economic assessment remains close to ours. Final domestic demand was, in our view, close to 4% above the pre-Ukraine invasion level in an economy that we estimate saw its potential output contract by a slightly smaller margin over the same period. Hence, stabilizing prices will require a meaningful slowdown in the economy. The strong expansion of domestic demand has also reduced the current account rapidly through higher imports, which in USD terms have risen back to slightly above the level in Q4-2021. Consequently, the current account surplus has fallen to our estimate of 1% of GDP in Q2 from close to 10% in 2022.”
He adds that “given the sanctions imposed on Russia, we doubt Russia would be able to fund a current account deficit, nor do we think the CBR would be willing to fund it from its reserves. Thus, we consider a balanced current account as a binding constraint on the economy, and hitting that constraint would lead to sizeable Ruble volatility. While the recent rise in oil prices will likely alleviate that risk somewhat, we interpret the front-loading of the hiking cycle partially as the Bank wanting to ensure it keeps the economy away from that BoP constraint.”
As Bloomberg notes, the precipitous decline in the Russian currency has thrust the central bank onto centre stage in an increasingly fraught debate over how to steer an economy battered by shrinking export revenues and isolated from international financial markets. And even with rates now at their highest in over a year, the market remains unimpressed as capital seeps out.
“The recent acceleration of ruble weakness might indicate that some cracks in the capital control might have emerged and therefore capital might be able to flee Russia at an increasing speed,” said Ulrich Leuchtmann, head of currency strategy at Commerzbank AG. “The rate hike will hardly convince those who might have a choice to keep their capital inside Russia.”
The central bank last made an emergency rate hike in late February 2022 with a rate rise to 20% in the immediate fallout of Russia’s despatching troops to Ukraine. The bank then steadily lowered the cost of borrowing to 7.5% as strong inflation pressure eased in the second half of 2022.