Feb. 13 (Bloomberg) -- Russia’s ruble capped its biggest weekly rally against the dollar in more than a decade after the central bank’s defense of the currency pushed speculators to curb bets on devaluation.

The ruble advanced 4.2 percent against the dollar this week, the most since December 1998 and the second-steepest gain among the 177 currencies tracked by Bloomberg after Chile’s peso. It is 4.5 percent stronger at 39.0954 against the central bank’s dollar-euro basket this week, 4.6 percent above the 41 level policy makers have pledged to defend.

Bank Rossii raised the interest rate on loans secured with bonds or other collateral through repurchase auctions twice in the past two weeks and increased the rate on Lombard loans Feb. 10 as it seeks to force banks and companies to convert foreign- currency stockpiles into rubles. Banks fled to dollars and euros during the past six months as the ruble dropped 30 percent against the U.S. currency amid sliding oil prices.

“People are unwinding their short positions as they realize the central bank is not going to let the 41 level break,” said Shahin Vallee, an emerging markets currency strategist in London at BNP Paribas SA, referring to bets traders make on when they expect a currency or asset to lose value. “The central bank’s resolve is helping it higher.”

Sergey Ignatiev, Bank Rossii’s chairman, said Jan. 22 the ruble will stay within a 26 to 41 trading range against the basket unless oil slides to and remains at $30 a barrel. He said he would raise rates, curb refinancing to lenders and buy and sell foreign-currency reserves to stabilize the currency after its “gradual devaluation.” Urals crude, Russia’s chief oil blend, dropped 1.1 percent to $44.39 a barrel this week.

Prosecutor’s Warning

As well as boosting borrowing costs and reducing the amount of cash available in central bank auctions, Russia is paying closer attention to what lenders do with their state-provided funds, with prosecutors warning 70 banks against converting state money into foreign currency, Kommersant reported Feb. 11.

Russian banks and companies earned as much as $25 billion betting on the ruble during its devaluation, said Maxim Raskosnov, a fixed-income and credit analyst at Moscow investment bank Renaissance Capital. The loans issued by the government were converted to foreign currency and used to fund ruble wagers, he added.

Stocks, Bonds Gain

Russian stocks rose, headed for the third weekly advance, as the stronger ruble, rising oil prices and a plan to exempt taxes on some oil exports buoyed investors’ confidence in the country’s assets. The Micex index climbed 5 percent today, extending this week’s gain to 10 percent. OAO GMK Norilsk Nickel, Russia’s biggest metals company, and OAO Polyus Gold, the largest producer of the precious metal, jumped more than 9 percent.

The government’s 30-year dollar bonds due 2030 rose today, pushing the yield 9 basis points lower to 9.30 percent.

In its bid to lower the amount of money on the market available to speculators, Bank Rossii reduced loans offered in so-called repo auctions to an average of 268 billion rubles ($7.8 billion) in February, compared with as much as 663 billion rubles in January. It continues to limit currency swaps, agreements whereby traders can bet on an exchange rate without selling foreign currency upfront, to 5 billion rubles a day.

The amount offered in unsecured loans, extended to more than 100 banks in November because of the seizure in credit markets, has also been cut, to 127 billion rubles so far in February, compared with the 533 billion rubles borrowed last month and the 1.3 trillion rubles lent in December, central bank data show.

Limiting Bets

Russia’s repo rate is now 12 percent, after four increases since the start of November. The Lombard rate, charged on borrowing secured against first-class bonds, is also 12 percent.

The ruble had a record weekly gain against the euro, appreciating 4.8 percent. The currency was little changed at 44.5117 per euro by 5 p.m. in Moscow, and was steady at 34.6787 per dollar. The basket is made up of about 55 percent dollars and the rest euros and is used to limit currency swings that disadvantage Russian exporters. It has been in place since 2005.

The ruble’s gains this week may be short-lived, according to MDM Bank and UBS AG.

The central bank may start limiting the ruble’s advance at around 38.75 to 39 versus the basket as a way of replenishing foreign-exchange reserves and balancing the current account, Mikhail Galkin, head of fixed-income and credit research at MDM Bank in Moscow said yesterday. A weaker currency boosts the competitiveness of exports, while benefiting local producers by making imports more expensive.

Buying Dollars

Bank Rossii is buying dollars and euros at about 39 to the basket today, because it doesn’t want the currency to trade too far away from the 41 level it regards as ideal, said Evgeny Nadorshin, senior economist at Trust Investment Bank, citing the bank’s currency traders.

Investors should end bets on the ruble’s advance against the basket after the currency’s gains this week, Roderick Ngotho, an emerging-markets currency strategist at UBS in London, wrote in a note to clients e-mailed today.

Holders of 1-month ruble non-deliverable forwards on the basket should sell their positions after the gains, the note said. The brokerage advised on Feb. 4 buying the contract once the spot rate reached 40.93, and now recommends “booking a 5 percent profit” on the trade, with the ruble appreciating to around 39.10 against the basket.

Defending Band

While Bank Rossii may be able to maintain the trading band throughout the first quarter, it may fail to keep the currency from breaking the 41 level in the second with the currency sliding to 41.09 by the end of June, BNP’s Vallee said. “Nothing has changed fundamentally in Russia.”

The world’s largest energy exporter is headed for its first recession since defaulting on $40 billion of debt in 1998, as demand for oil and natural gas abates amid the worst global financial crisis since the Great Depression. The nation reduced its reserves by 36 percent since August, striving to control the ruble’s decline. Holdings decreased $4.6 billion last week, the central bank said yesterday.

To contact the reporter on this story: Emma O’Brien in Moscow at eobrien6@bloomberg.net

Last Updated: February 13, 2009 11:24 EST