Russia to Tighten its Monetary Policy

Mar. 1 – The Russian Central Bank unexpectedly raised its key interest rate by 0.25 percent to 8 percent for the first time since the economic crisis over two years ago.

The Bank of Russia said in a statement that the rate hike, effective from Monday, was needed due to the high inflationary pressure and the expected rise of capital inflow into Russia as the world oil prices surge on the unrest in the Middle East.

“There are grounds for capital inflows into Russia due to higher oil prices,” the central bank said in a statement accompanying the decision.

By tightening its monetary policy, Russia is sending a strong signal that it views rising prices as a greater threat than slow economic growth.

Since the start of 2011, according to the Rosstat data, customer inflation in Russia reached 9.7 percent in a yearly term, mostly due to rising food prices. Earlier, in December 2010, central bank Chairman Sergey Ignatiev said monetary policy makers next year will focus on keeping inflation between 6 percent and 7 percent.

In addition to raising all of its rates by 0.25 percentage points, the central bank also tightened reserve requirements for liabilities to non-residents were raised by 100 basis points to 4.5 percent, and for other liabilities by 50 basis points to 3.5 percent. This should discourage inflows of speculative capital and a sign of the bank’s concern that a stronger ruble would hurt growth.

On Friday, Russia’s currency climbed 0.7 percent, hitting a 10-month high against the U.S. dollar.

Russia’s current bout of inflation was sparked by a summer drought that destroyed over one-third of its grain harvest last year and sent food prices soaring.

Although Russia has already scrapped food import duties and banned exports of grain, prices have continued to rise, throwing into doubt the central bank’s target of 6 percent to 7 percent inflation for 2011.

“It’s quite encouraging to see that they’re willing to adopt a quite unconventional … response,” David Oxley, an emerging markets economist with Capital Economics, said to Reuters.

Russia had responded with a deposit rate hike already from December 27, including increasing the one-week deposit rate to 3 percent from 2.75 percent, and reserve requirements for non-resident credit institutions to 3.5 percent from 2.5 percent in January, but this month’s moves stepped up the campaign.

“The most confusing thing about the central bank’s decision is that it followed the release of predominantly weak January macroeconomic indicators,” Alexander Morozov, chief economist at HSBC said to The Wall Street Journal.

“The macroeconomic mix was much more supportive of a rate hike one month ago, but the central bank decided to keep rates on hold.”

Among the government’s key priorities for pre-election year 2011, where a lot of budget expenditure is expected, are inflation control, domestic economic recovery stimulation and speculative capital inflow prevention.

“Considered all, the central bank measures seem to have less economical and much more both psychological and political nature,” Oleg Solntsev from Center of Macroeconomic Analysis and Short Term Forecasting told Russian business daily Vedomosti.

“There was so much political pressure (they had to move),” Ivan Tchakarov, analyst at Bank of America Merrill Lynch, told Reuters.