Why did the Russian central bank raise interest rates for the first time since the war began? Important reasons are the depreciation of the ruble and the expectation of a rising inflation rate. The price of oil is also contributing to the problems.
For months, the Russian central bank gave the impression of normalization and gradually lowered the key interest rate, which had been drastically increased at the beginning of the war of aggression against Ukraine in February 2022. Since September 2022, the interest rate has been only 7.5 percent and thus even below the pre-war level. But why did the central bank decide to raise interest rates for the first time since the beginning of the war and raised the key interest rate by a full point to 8.5 percent on Friday – more than most economists expected?
Central bank governor Elvira Nabiullina made it clear that another hike is the most likely scenario. Because although the rate of inflation was recently below the four percent mark targeted by the central bank, the monetary watchdogs see growing dangers of inflation. The central bank expects the inflation rate to end up at 5.0 to 6.5 percent this year and not return to the stability target of four percent until 2024. She is now trying to counteract this development.
With a flexible interest rate policy, the currency watchdogs were able to cushion the economic effects of the Ukraine conflict and the Western sanctions against Russia. Economic growth of 1.5 to 2.5 percent is expected this year, compared to a previous estimate of 0.5 to 2.0 percent for gross domestic product.
worry Currency Depreciation
A sentence from the central bank’s statement on the interest rate hike also points to another reason for the step: “Trends in domestic demand and the devaluation of the ruble since the beginning of 2023” have significantly increased the risk of rising prices, it said.
Over the past year, the ruble lost more than 35 percent of its value, but then recovered. But for months now, the Russian currency has been experiencing relatively continuous losses in value against the dollar and euro. According to observers, this is partly due to the oil price, which remains relatively low despite Opec+ decisions to limit global production.
The current interest rate increase should also be seen against this background – which will probably not remain the only one. “Given the sharp capital outflows and reduced support for the currency from the country’s current account surplus, this move alone is unlikely to prevent further ruble depreciation,” said Alexander Isakov, economist for Russia in Bloomberg Economics.
Recent political events, such as the Wagner mercenary uprising at the end of June, have further weakened the ruble’s external value. Experts assume that as a result, prices for goods and services should rise more sharply over the summer months.
Negative balance of payments in June
The central bank attributes the ruble’s weakness to falling exports and a recovery in imports. In June, Russia’s balance of payments turned negative for the first time since 2020. The central bank is now planning to use funds from the sovereign wealth fund NWF for foreign exchange market interventions from August. A limit of 300 billion rubles, or about 2.97 billion euros, per half year was set to take into account the liquidity situation in the domestic foreign exchange market.
Price pressures are likely to remain elevated for most of the second half of this year, according to Sofya Donets , economist at Renaissance Capital. “The acceleration of price growth given the unexpected magnitude of the ruble’s weakening has made a rate hike inevitable,” Donets said in a note ahead of the decision.