Surprising Move: Russia Faces Budget Pressure, Hikes Rates to Unprecedented 15%

Pedestrians walk past the Central Bank headquarters in Moscow, Russia, August 15, 2023. REUTERS/Shamil Zhumatov/File Photo

Bank of Russia Increases Key Rate by 200 Basis Points to 15%

The Bank of Russia surprised markets on Friday by raising interest rates by a higher than expected 200 basis points to 15%. This move comes as the central bank aims to address a weak rouble, persistent inflation, and increased government spending.

Since July, the Bank of Russia has raised interest rates by a total of 750 basis points, including an unscheduled emergency hike in August. Governor Elvira Nabiullina stated that current inflationary pressures have exceeded the bank’s expectations, with domestic demand outpacing the supply of goods and services, and rapid lending growth.

In addition to inflation concerns, the bank also considered a smaller rate hike of 100 or 150 basis points. Governor Nabiullina noted that the rate could remain unchanged or be raised further by the end of the year. The next meeting is scheduled for December 15.

Friday’s decision was also influenced by budget considerations. Russia has been increasing government spending, particularly in the defense sector, as it continues its military operations in Ukraine.

The Bank of Russia acknowledged that it may not achieve its target inflation rate of 4% next year, forecasting year-end inflation for 2024 to be between 4% and 4.5%.

Analysts had expected a rate hike of 14%, so the 15% increase took many by surprise. Following the announcement, the rouble experienced a significant boost against the dollar, reaching its highest level in over six weeks.

The Central Bank’s Tightening Cycle

The tightening cycle by the Bank of Russia began this summer due to a combination of factors such as inflationary pressure from a tight labor market, strong consumer demand, and a budget deficit. The falling rouble added to these concerns.

Following the emergency hike to 20% in February 2022, which was prompted by military operations in Ukraine and Western sanctions, Russia gradually lowered interest rates. Earlier this year, rates were as low as 7.5%.

The Bank of Russia predicts that inflation will range from 7.0% to 7.5% in 2023. The previous forecast had estimated year-end inflation to be between 6.0% and 7.0%. As of October 16, annual inflation stood at 6.38%.

The bank maintains a hawkish stance, planning to maintain tight monetary conditions for an extended period. However, it withdrew its guidance on the need for further rate hikes, describing the signal as neutral.

The bank’s key rate range for 2023 is set at 15% to 15.2%. This suggests that rates could potentially increase further, and Governor Nabiullina stated that it may be necessary. For 2024, the rate is projected to be between 12.5% and 14.5%.

Nabiullina emphasized that if signs of a sustained slowdown in inflation and cooling inflation expectations do not materialize, the bank is prepared to raise the key rate again.

Analysts have mixed opinions on what to expect moving forward. While some believe that the rate hike is not yet at its limit, others think it may have already reached its upper boundary.