Ruble Is Elephant In Room as Russia Invokes Inflation Threat

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Russia’s central bank Governor Elvira Nabiullina cited the threat of inflation as she warned future interest-rate cuts would be smaller and fewer. Economists see a different reason: the ruble.

After lowering its key borrowing cost at every meeting this year by at least 1 percentage point, Nabiullina said Monday that inflation would limit the scope for further easing. While prices are rising at almost four times the central bank’s 4 percent target, the pace has slowed from a 13-year high in March as consumer demand weakens.

“If the central bank was targeting inflation, they would emphasize downside risks given that demand is contracting faster than they expected,” Tatiana Orlova, the chief Russia economist in London for Royal Bank of Scotland Group Plc, said by e-mail. “There’s an elephant in the room, whose name is the ruble.”

The assessment highlights the skepticism among analysts that Russia has given up targeting a ruble exchange rate seven months after it announced the switch to a free float. This year’s best-performing currency became the worst in the past month and domestic bonds fell after the central bank spent about $3.8 billion buying foreign exchange.

“The Bank of Russia is trying not to upset the foreign-exchange market, as an aggressive cut could provoke a new bout of ruble weakening,” Orlova said.

Policy Tension

The central bank has denied it’s buying foreign currency to control the exchange rate. At a press conference Monday, Nabiullina reiterated the Bank of Russia’s stance that the purchases are aimed at boosting international reserves to $500 billion and are compatible with a free-floating exchange rate.

The dollar buying causes “tension,” Morgan Stanley said in an e-mailed note.

“We now see higher uncertainty around the Bank of Russia action, given potential conflict between its external targets -- foreign-currency reserves, and its domestic targets -- inflation,” Russia economist Alina Slyusarchuk wrote. “Depending on which target takes priority, the Bank of Russia would have to balance between cutting rates and intervening in the currency market so as not to destabilize the ruble.”

Russia’s February 2027 ruble bond erased gains and the ruble strengthened after the central bank’s rate statement. The currency traded 0.6 percent stronger at 54.1880 as of 5:09 p.m. in Moscow, paring its drop since the regulator announced the currency purchases in mid-May to 9.6 percent. The yield on the 2027 bond rose for a second day, adding 10 basis points to 10.85 percent, the highest in a week.

Taking Profit

Inflation, which soared to 16.9 percent in March from a year earlier, eased to 15.8 percent in May.

Monday’s statement doesn’t signal a serious policy clash, according to Yury Tulinov, head of research at PAO Rosbank, the Russian unit of Societe General SA

“The central bank’s priorities haven’t changed, with inflation at 4 percent being the No. 1 goal, followed by supporting the economy and avoiding excessive ruble devaluation,” he said by e-mail.

Traders reduced bets on Russian central bank interest-rate reductions to the lowest this year after Monday’s cut, which was the smallest since March. Forward-rate agreements are signaling 45 basis points of decreases in the next three months, the least since December, data compiled by Bloomberg show.

After 550 basis points of cuts so far this year, the central bank may not need to lower the key rate at future meetings, Nabiullina said. That prospect may crimp appetite for Russia’s OFZ ruble bonds, which have handed investors the best returns in emerging markets this year.

“It’s worth taking profits on OFZs in the short term,” Andres Vallejo, who helps oversee the equivalent of $3.2 billion at Kapital Asset Management in Moscow, said by phone Monday. “The rates decision signals that the scope for potential growth in OFZs this year is limited since further monetary easing will be more modest.”

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