Russia's Central Bank Should Now Cut Interest Rates Aggressively

Economic stabilisation in the first quarter and falling inflation justify a cut in interest rates to increase business confidence and to strengthen the recovery

Fri, Jun 12, 2015
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Elvira Nabiullina, Chair of the Russian Central Bank

On Monday the Central Bank in Russia is due to decide whether or not to cut interest rates.

Speculation is that the Central Bank will cut interest rates but there is wide disagreement about how much. The range discussed is between as much as 200 basis points (to 10.5%) and as little as 50 basis points (to 12%).

Here are some opinions about what the Central Bank will or should do from Western financial analysts:

Morgan Stanley:

"We expect the central bank to deliver a 150bp cut to 11% (and 350bp to 9% by end-2015). This is slightly more aggressive than the consensus forecast, which expects a 100bp cut. CBR governor Nabiullina expects inflation to slow down noticeably. At the same time, April economic activity data are showing signs of deepening recession.

"It looks like the CBR has been comfortable with the weaker rouble, introducing interventions to replenish reserves recently."

Barclays, Daniel Hewitt:

"We expect the Bank of Russia to cut its key rate 100bp to 11.5% at its meeting on Monday 15 June. This is a slower rate than the 150bp cut at its May meeting. We think the CBR is in slightly less of a hurry to cut rates at this meeting and we anticipate that it will further reduce its pace of cuts pace to 50bp in subsequent meetings. We think there is a slight risk that it will cut by only 50bp at this meeting.

"The cut cycle is mainly the result of an overshoot in December 2014 when the CBR raised its policy rate to 17%. At that time, the rouble was depreciating rapidly and clearly overshooting.

"Once the rouble selloff pressures ended in 2015, the CBR began cutting rates and subsequently the rouble appreciated for several months, facilitating further cuts. More recently, the rouble has entered into a depreciation stage that we think will cause the CBR to be more cautious."

RBS:

"Year to date, the CBR has shifted through its policy easing gears cutting 200bps in January, 100bps in March and 150bps in April. Given the recent volatility in both domestic and global markets, forecasting the size of its next move is no easy job. There seems to be a wide range of options, ranging from a hefty 200bps cut (rapidly weakening demand would support this) to a pause in the easing cycle (if the rouble again weakens above 56 vs. the dollar).

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"We think a further 100bps cut is the most likely outcome, allowing the CBR to continue easing at a cautious pace. However, we would not be surprised if it scaled back the pace of easing to 50bps against the backdrop of the expectations of the first Fed hike later in the year, and resulting high global market volatility."

Note the admission from Daniel Hewitt of Barclays that the ruble overshot its fall in December -- the first admission of that from a Western financial analyst we have seen.

My opinion is that the Central Bank should cut interest rates by 200 basis points to 10.5% and move to bring interest rates below 10% as soon as possible.

The ruble did soften in mid June, largely over speculation on the direction of oil prices in the run-up to the OPEC summit. In the event, though OPEC, as expected, did not cut production, oil prices have held up reasonably well. Predictions common in the winter of oil prices falling below $40 a barrel or even declining to $20 a barrel now look farfetched.

Further factors in the softening of the ruble in June were (1) the end of the hardening effect caused by company tax payments in May.  Taxes in Russia are paid in rubles so when companies have to pay taxes they must convert some of the dollars and euros they hold into rubles, which causes the ruble to strengthen; and (2) uncertainty about whether the Federal Reserve Board will raise interest rates in the U.S. and if so when. Rises in U.S. interest rates tend to attract money to the U.S., causing the dollar to strengthen and other currencies to fall relative to it.

In my opinion the Russian Central Bank can afford to take a relaxed view of all this. The end of the hardening effect of the May tax payments is temporary by definition, while the scale of the ruble’s fall last autumn means that the effect of an increase in U.S. interest rates on the ruble has already been factored in.

Beyond this the rise of the ruble in April and May was arguably going too far and was starting to undercut the gains in competitiveness the Russian economy has achieved because of the ruble’s fall.

The Central Bank’s focus in deciding interest rates should not be the precise level of the ruble but the direction of inflation. It is now falling fast with the Central Bank itself predicting that there might be deflation in August. It is unlikely that the softening of the ruble in June will materially affect this picture.

Given the improving inflation picture the Central Bank can afford to cut interest rates aggressively, strengthening the recovery in confidence that was already evident in May, paving the way for the full recovery in the economy it is predicting will happen in the last quarter.

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