The Central Bank of Russia (CBR) unexpected hiked overnight interest rates by 0.25 percentage point to 8.25% to head off rising inflation, in a move that economists have criticised and fear may slow Russia's growth further. The hike goes into force September 14.
Inflation has been creeping up all summer, fuelled by a poor harvest that is putting upward pressure on prices; food accounts for about a third of the average Russian shopping basket, so a poor harvest feeds quickly into inflation figures.
Annualized inflation rates already broke the CBR's year-end target of 6% when they topped 6.3% on September 10, the most recent data. The CBR started the year predicting about 6% for the whole year, but more recently has been forced to hike its forecast due to the harvest and now Russia is on track for at least 7%. Russia started this year with inflation at a 20-year low of under 4%.
"A poor grain harvest and inflation in related sectors remained the major driver of high inflation in early September: egg prices rose 2.8% since the beginning of the month, wheat flour 1.7%, wheat bread 0.8% and chickens 0.7%. The effect of regulated tariff revision seems to be evaporating, as heating tariffs grew only 0.6% and water supply tariffs rose 0.3-0.5% over last week," Troika Dialog said in a note last week.
However, economists have been arguing for months that the CBR should not be in the business of fighting food price-related inflation, as those prices rises are due to an act of God and have nothing to do with fiscal management, argues Ivan Tchakarov, chief economist for the CIS and Russia at Renaissance Capital, a view that is shared by Danske Bank and Troika Bank analysts. "The Central Bank's move will barely affect this sort of inflation," says Evgeny Gavrilenkov, chief economist at Troika Dialog.
To try to bring food-related inflation down by increasing interest rates inevitably leads to distortions in the economy that do as much damage as inflation. On the fiscal score, the CBR has done a good job and underlying inflation, due to economic not atmospheric factors, is under control. It says that the "core" inflation accelerated to 5.5% in August and this is the part of inflation that should be attributed to monetary factors, but not food prices.
Once the food spike passes, inflation should come down again as the CBR's increased lending to the banking sector - the bank has just announced an expansion of lending by RUB1 trillion - is totally under the CBR's control and it can switch this off at any point to bring inflation down without the need to hike rates. In order to do this, the CBR is waiting for some confidence to return to companies that will spur growth. In effect this CBR lending to banks is Russia's own version of quantitative easing that, unlike Europe and the US, has already been running for months.
Elena Kolchina, head of fixed income at Renaissance Asset Mangers, says: "Inflation this year will probably come in at 6-7%, but it is expected to stabilise at around 4.5-5.5% in the medium term."
Still, given the years that Russia suffered from hyperinflation, it remains a sensitive issue and the CBR has only recently switched from maintaining exchange rate stability to inflation targeting. It seems that the central bankers had a bit of relapse and have gone back to their old ways.
Analysts at Danske Bank said in a note that the hike will not help the economic recovery: "Despite slowing economic growth, Bank Rossii's main target has become inflation. The Russian economy grew 4% year-on-year in Q2 12 versus 4.9% in Q1 12. The economy expanded 2.6% year-on-year in July versus 3.8% year-on-year in June... We believe that tightening monetary policy does not help much to restrain price growth in Russia, as it does not have much of a monetary nature."
And the CBR may have more hikes up its sleeve now, as this hike shows a change in policy. VBT Capital analysts say that another 0.25% hike could be in the works. The next policy meeting is scheduled for early next month. "A hike from CBR should be treated as a step aimed at containing inflation expectations and building regulator's credibility within inflation targeting framework. At the same time recent market developments showed that under current framework liquidity conditions may matter more than outright level of base rates," VTB said in a note.
The CBR missed target at the start of this month was one contributing factor to the rate hike, but this week's strong lending results was another. Consumer lending was up 43% over the first half of this year at what the CBR considers to be "overheating" levels; the CBR says consumer lending growth of 28% is the maximum comfortable level. However, the consumer borrowing contrasts strongly with corporate lending which is rising much more slowly and leading to industrial production slow down.
"The CBR yesterday surprised the market with a 25bp hike in rates, suggesting an intention to keep the 6% full-year inflation target. While we consider this decision as appropriate given the overheated retail lending market, we also believe that it might be too late to affect this year's inflation trend," said Natasha Orlova, chief economist with Alfa Bank in a note today who is predicting a year end figure of 6.7%.
The bottom line is if this rate hike will cause the already slowing economy to slow further. The CBR seems to be taking the line that current growth - although less than boom-time levels - is robust and it can afford to tackle inflation without hurting growth too much, a view that is not shared by many of Moscow's economists.
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