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US Financial Warfare Forces Russian Central Bank on the Defensive

Ruble's fundamentals are sound, it should be rising on the exchange rates, instead the RCB is forced again to raise interest rates just to keep it from sliding

The Central Bank of Russia (CBR) surprised analysts by hiking its monetary policy rate by 25bp to 7.5% -- the central bank’s first increase in interest rates since 2014.

The increase was in reaction to recent emerging market volatility, ruble weakening, and sanction pressure on Russian assets. The last time the CBR hiked rates was an emergency rate hike in 2014 to 17% to steam the meltdown of the ruble after oil prices crashed that November.

Today’s move shows that the CBR is taking sanction risks seriously as instead of keeping the rate unchanged and resorting to issuing a tougher guidance, it decided to front-load with a 25bp hike ahead of the anticipated US sanction toughening this autumn.

The CBR had already indicated that no rate cuts should be expected any time soon, as the governor of the CBR Elvira Nabiullina said last week that the regulator sees “little if any” reasons for monetary easing, 

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naming high global financial market volatility and inflation moving closer to 4% target faster than expected under external pressure as main risk factors.

The move also bolsters Nabiullina’s reputation as one of the most conservative central bankers in the world and underscores the central bank’s independence as the government would have preferred to see a growth-boosting cut in rates.

The CBR's interest rate action surprised Russia’s analysts and defied the government, but did not make as bold a move as the central bank of Turkey that on September 13 ramped up the rate up by surprise 6.25pp from 17.75% to 24%, trying to tame the weakening of the currency and rising inflation. Out of 24 analysts surveyed by Reuters 23 expected the CBR to maintain the rate at 7.25%. 

However, Sberbank CIB allowed for a rate hike of up to 50bp to prevent the continuous selloff of Russian assets. Other analysts too claimed that the market expects the CRB to react and has priced in at least 25bp rate hike, with any decision more dovish than that possibly triggering renewed selloff. 

CBR keeps ruble volatility in check despite government pressure

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The move shows that the CBR is taking sanction risks seriously as instead of keeping the rate unchanged and issuing a tougher guidance, it decided to front-load with a 25bp hike ahead of the anticipated US sanction toughening this autumn.

In addition the hiking the rate, the CBR also said it will stop weekly purchasing foreign currency off the market for the Finance Ministry until the end of 2018. Previously in August the CBR already stopped the FX interventions in reaction to strong ruble weakening. 

Some analysts criticised the CBR decision as deviation from the policy of free-floated national currency, arguing that CBR's interest rate hike seems to be motivated by ruble weakening above all, especially given still low inflationary risks (see below).

At the press conference following the interest rate decision Nabiullina commented that it was excess ruble volatility, not any target ruble rate that the regulator is after.

"Once we estimate that the volatility on our markets is down, no matter at what ruble exchange rate it will be, we [the CBR] don't care about the specific rate, we will resume regular currency purchases," she said. 

By deciding to increase the rate, Nabiullina has also once again asserted her independence from Kremlin and the government, which should calm the market in the face of the possible future volatility. 

Despite some seeing the rate hike as a chance to stop the panic on the ruble market the government warned the CBR against the rate hike. Presidential advisor Andrei Belousov said at the Eastern Economic Forum that increasing the key rate would be "extremely unwelcome action, as it would slow down investment activity, economic growth, and lead to extra budget spending."

The head of the Ministry of Industry and Trade Denis Manturov also argued against the rate, reminding that many local industries profit from cheap ruble. 

Inflation forecast up considerably

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Consumer Price Index (CPI) inflation in August tipped above 3% registering 3.1% year-on-year according to the September 5 report of Rosstat statistics agency. Inflation reading in August was up from July's 2.5% y/y and above the CBR's forecast of 2.8-3%, reaching the highest since September 2017. However, its still remained close to post-Soviet record-lows.

BCS Global Markets analyst Vladimir Tikhomirov previously suggested that the central bank will only increase the key borrowing rate if inflation exceeds 5%. "Underlying price pressures are still extremely weak, we think that the central bank will hold off from tightening policy," Capital Economics commented on September 5.

But the CBR has surprised the analysts not only with increasing the rate, but also with considerably worsening the inflation forecast, now seeing the CPI in 2018 at 3.8-4.2% (up from 3.5-4%), and for 2019 to 5-5.5% (up by 1pp from previous 4-4.5%). 

At the press-conference Nabiullina attributed the worsening of the inflation outlook to VAT hike in 2019 and the higher country risk premium. While the CBR did not change the neutral interest rate target of 6-7% at inflation of 4%, the higher inflation outlook means "we are already in the neutral interest rate range".

What to expect next?

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Previously in spring and summer CBR gave clear signals that the monetary easing cycle will remain on hold into 2019, as the regulator was cautious on inflationary effects of the adopted VAT hike to 20%. Prior to that the rate-cutting cycle that the CBR started at the beginning of 2018 was interrupted by the latest round of US sanctions in April.

The latest September rate hike thus made the second this year the CBR had to deviate from its guidance and got the analysts wondering what to expect next. The commentators have split into two camps, some seeing the rate hike as overly impulsive and petty, other seeing it as a justified firm signal to a volatile market.

Nabiullina admitted that the rate hike decision was taken "promptly", but her comments seem to indicate that inflation outlook worsening is more of a worst-case-scenario than an actual expectation.

"Regarding seeing this as a start of rate hiking cycle, we do not exclude hiking the rate further, but only if the risks we mention will materialise," the governor said, adding that "this will not necessarily happen and we cannot assert that this marks the beginning of the rate hiking cycle."

While the head of the CBR still expects the monetary easing cycle that was started in the beginning of this year to resume, she does not see the conditions for this forming before the end of 2019, first half of 2020 now. 

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