CBR hikes rates aggressively to curb RUB sell-off

Late last night the Russian central bank (CBR) in a surprise move hiked its key policy rate by 650bp to 17.0% from 10.5%. So far the CBR has been holding back in terms of ‘emergency hikes’ and as such the hike marks a change in policy stance.

The hike comes after the RUB on Monday saw is biggest one-day decline since the Russian crisis in 1998 and in our view it is a clear signal that the CBR now thinks that the sell-off is threatening financial stability. The CBR is likely also reacting to mounting political pressure to act to curb the RUB sell-off.

The CBR is stuck between a rock and a hard place. On the one hand there are – in addition to the political pressure – worries about rising inflation on the back of the RUB sell-off and mounting funding problems for Russian corporations’ foreign currency loans. On the other hand, aggressive monetary tightening, which we are now seeing, is very likely to have seriously negative implications for growth and might also increase financial distress as consumers and corporations are seeing sharply rising funding costs.

In our view the CBR will have a hard time stabilising the RUB as long as the drop in the oil price continues, so it might turn out that yesterday’s aggressive rate hike will not be enough to stabilise the RUB.

Furthermore, we would argue that the aggressive rate hike marks the first major change of course from the CBR after the recent announcement that it would allow the RUB to float freely. The rate hike shows that the CBR’s commitment to the float has limits. It should also be noted that the rate hike is likely to fuel speculation that the Russian authorities could introduce capital and currency controls if the RUB sell-off continues. We would at this point not rule out such actions, even though we want to stress that the CBR – rightly so – to this point has been against such actions, but clearly the political pressure is mounting.

Overall, the continued drop in the oil price and hence in the RUB, combined with the now very significant monetary tightening, is likely to deepen the crisis in the Russian economy. The country has effectively entered recession and there are no signs of any near-term relief for the Russian economy, which is likely to fall deeper into recession in the coming quarters.