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Russia’s central bank raised its key interest rate by 3.5 percentage points to 12 percent at an extraordinary meeting after the ruble fell below 100 yuan to the dollar.
The currency surged ahead of Tuesday’s bigger-than-expected rate hike, but has since broken some gains to trade at 98 yuan to the dollar.
The crash of the ruble, which fell to 102 yuan against the dollar on Monday, highlights worries about Russia’s economic outlook almost a year and a half after President Vladimir Putin’s full-scale invasion of Ukraine.
The country’s economic policymakers are struggling to balance conflicting demands to steer the economy through economic growth and Western sanctions while keeping the ruble stable.
But the central bank said further interest rate hikes could be needed to stabilize the currency “if inflation risks rise”, and many analysts believed that the ruble’s excess liquidity would push up imports, which in turn would push up prices. It claims to be the main factor driving up the pressure.
After Russia plunged into recession last year, it will need to borrow big bucks to help the country recover and fund Putin’s war machine at a time when interest rates are low and inflation is accelerating at the same time as the ruble is declining. there were.
The central bank said it had decided to “limit risks to price stability” after some inflation measures rose above 7%. But he added that mounting pressure on the ruble has raised inflation expectations.
“Growing domestic demand beyond expansion potential” [monetary] “Supply will affect the ruble’s exchange rate behavior by reinforcing sustained inflationary pressures and boosting import demand,” the central bank said.
The report said further price increases created a “significant risk” that Russia would miss its target of lowering inflation to 4% next year, arguing that higher interest rates would help achieve that target.
The central bank, which dropped its exchange rate target in 2014 and switched to a floating exchange rate regime, said the decision on whether to raise interest rates further will depend on inflation data and Russia’s success in adapting to Western sanctions and other internal and external “risks.” said it would be based on .
Analysts at Russian investment bank Cynara said a higher-than-expected rate hike signaled an early end to the tightening cycle.
“We will need more time to talk about sustainable stabilization and currency appreciation,” said Sofia Donets, chief Russian economist at Renaissance Capital, an investment bank in Moscow. [for the rouble]. While this rate hike would clearly hurt Russia’s growth, it would help contain inflation risks. “
Russia’s central bank has been reluctant to sell dollars and euros to boost the ruble after Western countries froze about $300 billion in foreign exchange reserves last year, and Russian policymakers said the ruble had fallen. have little means to support
The central bank announced last week that it would suspend foreign currency purchases until the end of the year to “reduce volatility.”
One of the main reasons for the ruble’s depreciation is that Russia’s current account surplus is shrinking, down 85% year-on-year in the first seven months of 2022.
Russia’s accommodative monetary policy has helped finance ballooning military spending and social programs such as subsidized mortgages and payments to soldiers’ families.
But while that toolkit has helped boost growth, sanctions have cut export earnings, widened Russia’s budget deficit, and made it even more dependent on imports — a factor that fuels inflation. .
Export earnings remain low, not only because of Western price caps, but also because exporters do not repatriate a significant portion of their foreign currency earnings, despite July’s rise in oil prices.
That put an unprecedented ruble denominated 40% of Russia’s exports in June, adding pressure on the exchange rate.
“Measures are also needed to reduce the excess liquidity of the ruble,” said Denis Popov, chief analyst at Russian state-owned bank Promsvyazbank, in a note.
Analysts said the central bank’s decision would not have a major impact on the ruble.
“The interest rate adjustment mechanism will be reflected in the exchange rate with a certain lag and may not be a quick solution to stabilize the exchange rate,” said Natalia Lavrova, chief economist at BCS Global Markets. Stated.
Central bank governor Elvira Nabiullina, who has prioritized economic stability during his ten-year tenure through a hawkish inflation policy, has come under rare public criticism from state hardliners after the weak ruble. .
However, the Kremlin’s reluctance to cut social and military spending has limited the means Russia needs to prevent the ruble from depreciating to non-market mechanisms such as capital controls.
University of Chicago professor Constantine Sonin said central banks could turn to more unorthodox policies if they wanted to.
“The arsenal of financial repression is essentially limitless. What is stopping them? There is also the possibility of a black market. They could shop at “luxury” stores, but they were expensive, including the risk of being arrested. “