Russia: preparing to fight inflation

The Central Bank of Russia (CBR) decided to keep the benchmark interest rates unchanged today, which came as no surprise. However they decided to lower the 1-day RUB swap rate from 8.% to 6.5% as of June 18th.  The CBR noted in their press release that the interest rates are “appropriate” for the coming months.

The CBR press release notes that the decsision is neutral for monetary policy, and the lowering of the 1-day swap rate is just meant to “widen the possibilities for credit companies to attract RUB liquidity from the CBR”. This is a strategic move: it will help lower the volatility in the money market and thus help improve the transmission of the monetary policy. This will be additional tool (to repos) to prevent spikes in interest rates upon changes in excess liquidity in the interbank market. Lower volatility makes RUB attractive for investors. Indeed, the CBR hint in their statement, in line with comments over the previous weeks, that RUB weakening poses risks to inflation.

Figure 1. Key policy rates unchanged for now

Figure 2. RUB excess liquidity in the banking sector has declined

Figure 3. FX swaps will be additional tool to liquidity provision

The CBR notes that inflation risks are increasing. While acknowledging the risks of economic slowdown from industrial production, the CBR  notes that the domestic consumption demand is still strong and the development in the labour market form “favourable” conditions for sustainable demand going forward.

The times of “easy ride” for the CBR are over: inflation is bottoming out. The tightening labour market, upcoming postponed tariff hikes and RUB weakening over the past few months will push inflation higher for the rest of the year. Inflation reached  3.6% y/y in April, now at 3.7% y/y and we expect it to reach 3.9% y/y in June. After the tariff hike in July inflation will likely spike in July and exceed 6% y/y in August. The RUB weakening since May, if sustained, could add a further 2%-points to CPI this year. So, the CBR will have hard time trying to keep it within the inflation target of 5-6% in 2012. This implies policy tightening will be needed in H2. This also implies further RUB weakening needs to be avoided  – and, ideally, reverted.

Figure 4. The postponed tariff hikes will add to inflation in July

Figure 5. TIghtening labour market will provoke policy tightening in H2

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