Serbia Raises Benchmark Rate in Battle to Curb Inflation

Serbia’s central bank unexpectedly raised borrowing costs for a second time this year as it battles to bring Europe’s second-highest inflation rate back to its target band.

The Belgrade-based Narodna Banka Srbije boosted the one-week repurchase rate by a quarter-point to 11.75 percent, its eighth increase in nine meetings. Nine of 22 economists in a Bloomberg survey predicted a rate increase of between a quarter-point and a full percentage point. Twelve forecast no change and one saw a 25 basis-point cut.

Serbian rate-setters are running counter to other authorities in eastern Europe, where borrowing costs are falling to halt economic slowdowns amid the debt crisis. The central bank is trying to slow inflation to its target band of 2.5 percent to 5.5 percent this year after prices jumped 12.2 percent in 2012.

“The NBS is certainly winning the battle in terms of trying to show which central bank in the region is the most hawkish,” Timothy Ash, chief emerging-markets economist with Standard Bank Plc in London, wrote to clients today. “I sense herein the NBS is still struggling a bit with the credibility gap after recent changes at the top, and wants to prove that it is fully independent, and to do whatever it takes to break the back of inflation and the still wide current-account deficit.”

Dinar Advances

The dinar has advanced because of tight monetary policy, with the central bank raising its benchmark interest rate seven times since June by a total of 2 percentage points to 11.5 percent, to bring inflation back to the target of 4 percent, plus or minus 1.5 percentage points by the end of 2013.

The unit gained 1.2 percent against the euro last month, the second-largest advance behind the Romanian leu among more than 170 currencies tracked by Bloomberg. It traded at 111.3443 at 4:44 p.m. in Belgrade, up from 111.5296 before the decision.

The central bank is concerned with the impact of a 9.3 percent gas price increase this month and an electricity price hike of 10 percent to 12 percent, UniCredit Research economist Carlos Ortiz said in a note to investors after the rate announcement. With inflation “likely to peak” in the first quarter at about 15 percent, another quarter-point increase may come next month, he said.

“The monetary-policy reaction is directed at preventing a spillover effect from higher regulated prices on other prices,” the central bank said today in an e-mailed statement.

Containing Inflation

The National Bank of Serbia expects low comparable inflation figures from last year and higher regulated prices to weigh on inflation in the coming period. With the arrival of the new farming season, the central bank expects to see the full impact of “monetary-policy measures taken so far,” with inflation returning to the target by the end of 2013.

The central bank expects the stable dinar, weakening inflationary expectations as well as low aggregate demand to have “a strong disinflationary impact in the coming period,” according to today’s statement.

Inflation has been accelerating since April 2012, when it fell to a 30-year low of 2.7 percent, due to rising food costs amid a drop in farm output. Prices continued to rise even as the economy fell into its second recession in three years and consumer demand contracted as wages remained tame and unemployment expanded.

“We believe that the peak in rates will be around 12 percent,” Societe Generale emerging-market analysts including Guillaume Salomon in London, said in a note to investors today.

Price Increases

Prime Minister Ivica Dacic’s six-month-old coalition government is seeking to curb price increases and restart growth after the economy contracted an estimated 1.7 percent in 2012, betting on higher exports of Fiat SpA cars produced in Serbia and more sales of crude oil products abroad for growth.

His Cabinet, dominated by the Socialists of late strongman Slobodan Milosevic and former nationalists who together ruled in the late 1990s, when Serbia faced sanctions, bouts of hyper-inflation and currency denominations, is keen to prove it can keep the dinar stable in an economy where 70 percent of all transactions is still in euros.

Serbian monetary policy tightening also included a re-introduction of reverse repo operations in December, with policy makers keen on mopping up excess liquidity to avoid an impact on demand, inflation and the dinar’s exchange rate.