Russia Targeting ‘Bit of Everything’ as Deeper Cuts Thwarted

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Russia's Central Bank Governor Elvira Nabiullina
Since central bank Governor Elvira Nabiullina's unexpected cut on Jan. 30, oil, Russia’s main export earner, rebounded 8 percent and a cease-fire took hold in eastern Ukraine. Photographer: Andrey Rudakov/Bloomberg

The Bank of Russia’s juggling act is straining its ability to administer a bigger dose of monetary easing to an economy in crisis.

When the central bank meets on Monday to review interest rates, the spotlight will be on its policy focus after $3.6 billion in foreign-exchange purchases in less than a month cast doubt on its commitment to allow the ruble to trade freely. While all economists in a Bloomberg survey predict a reduction from 12.5 percent, most forecast a one-point cut, matching the smallest decrease since an easing cycle started in January.

The choice will lay bare Governor Elvira Nabiullina’s priorities as she nurses the economy back to health and navigates the world’s most volatile currency. While a reduction of 150 basis points or more would befit a “conservative, inflation-targeting central bank,” a half-point cut may betray a bigger concern about another round of ruble weakening, according to Royal Bank of Scotland Plc.

“The Monday meeting will be a test of what the central bank is actually targeting,” said Tatiana Orlova, chief Russia economist at RBS in London. “The economists seeing a 100 basis-point cut seem to think that the Russian central bank is now a proper emerging-market central bank targeting a bit of everything, which is probably not too far from the truth.”

Modest Easing

Derivatives traders have scaled back their bets on a decline in borrowing costs since the central bank’s program to rebuild reserves to $500 billion began on May 13. Forward-rate agreements are signaling 35 basis points of decreases in the next three months, the smallest this year and down from last month’s high of 188 basis points in the first days of May.

With the central bank poised to lower rates, the ruble weakened for the first time in five days and traded 0.9 percent weaker at 54.82 against the dollar at 2:24 p.m. in Moscow. Five-year government bonds fell, pushing the yield two basis points higher to 10.93 percent.

Russian local-currency debt handed investors 35 percent returns in 2015, the most in the Bloomberg Emerging Market Local Sovereign Index.

When policy makers moved to a free-float regime ahead of schedule in November, they pledged to avoid interventions on the foreign-exchange market unless the ruble’s swings threatened financial stability. The central bank has since defended its currency purchases as compatible with a free-floating exchange rate.

The operations have come under criticism from Economy Minister Alexei Ulyukayev and lenders including PAO Rosbank and ING Groep NV as going against its free-float policy, in which the market sets the ruble’s exchange rate.

Staying Vigilant

With price growth almost fourfold its mid-term target of 4 percent, the Bank of Russia’s presence on the currency market means it has less leeway to roll back its emergency rate increase to 17 percent in December.

“The central bank switched its focus to the currency market, which means it may stay vigilant to inflation risks,” Alexey Pogorelov, the chief economist for Russia at Credit Suisse Group AG, said by e-mail.

While Nabiullina has said that price growth is “under control,” she’s also pointed to inflationary and currency risks as an obstacle for a faster rollback of last year’s emergency rate increase. The goal of curtailing domestic prices remains a challenge, Prime Minister Dmitry Medvedev said at a cabinet meeting in Moscow Thursday.

Inflation slowed to 15.8 percent in May after accelerating to a 13-year high of 16.9 percent in March.

Two Chairs

Nabiullina’s policy restraint comes at a time of deepening recession. After a 1.9 percent decline in the first three months, the economy will contract about 4 percent in the second and third quarters, according to Bloomberg surveys.

“It’s always hard to sit on two chairs at once, and an active currency policy is hard to reconcile with the goal of managing prices,” Pavel Trunin, who runs the monetary-policy department at the Gaidar Institute in Moscow, said by phone. “The decision to grow reserves isn’t bad, but the moment that was chosen casts doubts on the consistency of central bank actions.”

The ruble is the world’s best performer this year against the dollar with an 11 percent gain after losing almost half of its value in 2014. The Russian currency’s three-month implied volatility, a measure of exchange-rate swings, is at 22 percent, the highest globally, according to data compiled by Bloomberg.

“Given the pressure on the ruble, we suspect that the Bank of Russia will slow the pace of rate cuts,” said Neil Shearing, chief emerging-market economist at Capital Economics Ltd., who sees a 100 basis point reduction.

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