Russian Ruble Seen Extending Drop as Politics Trump Higher Rates

The ruble’s biggest rout in seven weeks risks worsening as a surprise interest-rate increase curtails growth and the Ukraine crisis raises prospects for more sanctions, Capital Economics Ltd. and Morgan Stanley said.

The Russian currency depreciated 0.7 percent to 36.0305 per dollar by 6:31 p.m. in Moscow after a surprise interest rate increase failed to offset Standard & Poor’s move to lower Russia’s credit rating to one level above junk. The exchange rate may weaken 7.6 percent from current levels to 39 per dollar by the end of 2014, Liza Ermolenko, a London-based emerging-market economist at Capital Economics, said in a research note.

The currency, which rose last month after the central bank raised its benchmark rate by 150 basis points, has come under pressure as an accord to disarm separatists in east Ukraine unravels. S&P said more downgrades are possible if the economy deteriorates and the U.S. and Europe expand sanctions. The economy faces the slowest growth since the 2009 contraction, according to forecasts compiled by Bloomberg.

“While the increase in rates may help mitigate some of the negative speculation on the ruble, we do not think that it will bring about sustained support for the currency,” Morgan Stanley analysts led by Rashique Rahman said in e-mailed note. “The underlying drivers to our bearish view on ruble are downside risks to growth and balance of payment pressures, and both factors continue to deteriorate on the back of political risks.”

Slowing Growth

Economic growth in the country of 140 million people will slow to 1 percent in 2014, according to the median of 40 forecasts compiled by Bloomberg. Inflation accelerated to an estimated 7.2 percent as of April 21, the central bank said. Annual price increases reached a nine-month high of 6.9 percent in March.

The ruble will weaken to 36.51 per dollar by year-end, according to the median of 40 forecasts compiled by Bloomberg. The exchange rate’s three-month implied volatility jumped 5.9 percent today to 11.94, the highest since March 18.

The currency “remains extremely vulnerable to an escalation of tensions in Ukraine and a fresh round of economic sanctions,” Ermolenko said.

The central bank raised the one-week auction rate to 7.5 percent from 7 percent “due to higher inflation risks,” saying in a statement that the probability of price increases exceeding its 5 percent target at the end of 2014 had “increased substantially.” It said its measures will help cap inflation at no more than 6 percent this year.

‘Mild Support’

“Higher policy rates should help in getting control over inflation via reduction in domestic lending growth and support to the currency,” Alexander Morozov, a Moscow-based economist at HSBC Holdings Plc, said in a research note. “Currency market stability, in turn, anchors depreciation and inflationary expectations.”

The U.S. and its allies have an additional list of sanctions ready and will act if there is no progress in de-escalating the crisis in Ukraine, where security forces are moving against pro-Russia separatists, U.S. President Barack Obama said yesterday in Tokyo.

The ruble has fallen 1.2 percent against the dollar this week, capping the biggest decline since the period ended March 9. It has retreated 8.8 percent this year, the most among 24 developing-country currencies monitored by Bloomberg.

The rate increase will offer “only mild support” for the currency, whose fluctuations will be based more on political events, Moscow-based OAO Promsvyazbank analysts Igor Golubev and Alexei Egorov said by e-mail.

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