Bloomberg News

Russia Unexpectedly Raises Main Rate as S&P Lowers Rating

April 25, 2014

An Armed Man Stands Outside a Building in Slavyansk, Ukraine

The escalating crisis in Ukraine and Russia’s annexation of Crimea last month led to the worst standoff against the U.S. and Europe since the collapse of the Soviet Union leaving policy makers to struggle with an economy on the brink of recession with the inflation rate above the central bank’s target for a 19th month as the ruble fell. Photographer: Kirill Kudryavtsev/AFP via Getty Images

Russia’s central bank sprung a surprise by raising its benchmark interest rate after Standard & Poor’s downgraded the world’s biggest energy exporter for the first time in six years as capital outflows threaten growth.

The central bank, whose scheduled decisions have been correctly predicted by the majority of economists every month since September 2012, increased the one-week auction rate to 7.5 percent from 7 percent today, according to a website statement. Hours earlier, S&P cut the nation’s sovereign rating to one level above junk, the lowest investment grade, on par with Morocco and Uruguay, and which Russia last had in 2005.

The central bank, which raised borrowing costs once in the months after the collapse of Lehman Brothers Holdings Inc., increased rates for a second time this year as fallout from the Ukrainian crisis sent investors fleeing Russian assets. The standoff over Ukraine risks stoking “additional significant outflows,” endangering the economy, S&P said.

“We believe the central bank’s decision is a response to the cut of Russia’s sovereign rating by S&P and a reiteration of its negative outlook,” Natalia Orlova, chief economist at Alfa Bank in Moscow, said by e-mail. “We believe the policy rate decision represents the central bank’s guidance for negative newsflow in the nearest future.”

The surprise increase failed to prop up the Russian currency. The ruble, the second-worst performer among 24 emerging-market currencies tracked by Bloomberg, depreciated 0.7 percent to 36.0360 per dollar as of 7:03 p.m. in Moscow. It’s trading at 42.2642 against the central bank’s target basket, compared with a record-low 43.0570 reached on March 14.

Temporary Increase

The monetary authority, which has been under the stewardship of Chairman Elvira Nabiullina since June, kept its key rate at 7 percent at their last meeting on March 14. The central bank made what it called a temporary increase from 5.5 percent the previous week after President Vladimir Putin secured lawmakers’ approval to send troops into Ukraine.

“Negative market implications from the S&P’s action outscore positive implications from the Russian central bank’s decision, especially if we consider this news in the context of negative geopolitical developments today,” Alexander Morozov, a Moscow-based economist at HSBC Holdings Plc, said by e-mail.

President Barack Obama discussed a possible expansion of sanctions with European leaders today after U.S. Secretary of State John Kerry said Russia is running out of time to ease tensions in Ukraine.

Asset Selloff

The escalating crisis is pushing the Russian economy to the brink of recession with inflation above the central bank’s target for a 19th month and the ruble trading near a record low. The tensions have sparked a selloff in Russian assets as the U.S. and the European Union imposed sanctions against officials and threatened to broaden the penalties.

“The central bank’s ability to support economic growth amid escalation in Ukraine is rather poor,” Vladimir Osakovskiy, chief economist for Russia at Bank of America Corp., said by phone. “That’s why it is focusing on ruble’s support.”

The yield on government debt due February 2027 jumped 24 basis points to 9.6 percent, taking this week’s climb to 60 basis points. Russia’s credit risk rose to the highest in more than two years and the Micex stock index slid 1.6 percent, capping the worst week since the five days to March 14.

Economy, Outflows

Gross domestic product may expand less than 0.5 percent this year or not grow at all, according to Finance Minister Anton Siluanov. GDP grew 1.3 percent in 2013, the slowest pace in four years. Capital outflows surged to $50.6 billion in the first quarter from $27.5 billion a year earlier. That compares with $63 billion in all of 2013.

“The Russian central bank has yet again demonstrated a textbook approach to monetary policy,” Tatiana Orlova, a senior economist at Royal Bank of Scotland Group Plc in London, said in e-mailed comments. “Inflation is way above target, and the central bank cites this as the main reason for the hike. We expect this move to bring only a temporary relief to the ruble market. The rate hike is powerless to stem capital outflows which are fueled by the high geopolitical risks.”

All but one of 23 analysts in a Bloomberg survey had forecast no change by the central bank, with one predicting an increase to 8 percent.

Policy makers said in the statement that “the probability of inflation exceeding the 5 percent target at the end of 2014 has increased substantially.” The economic growth will continue to slow this year, the central bank said.

Inflation Spike

Inflation accelerated to an estimated 7.2 percent as of April 21, according to the statement. The regulator said that today’s decision is seeking to contain price growth at no more than 6 percent by year-end, adding that it doesn’t plan to cut the key rate in the “coming months.”

S&P said it may lower the rating further “if tighter sanctions were to be imposed on Russia and further significantly weaken the country’s net external position.”

Investors routinely ignore ratings companies’ decisions. In almost half the instances, yields on government bonds fall when a rating action by Moody’s and rival Standard & Poor’s suggests they should climb, or they increase even as a change signals a decline, according to data compiled by Bloomberg on 314 upgrades, downgrades and outlook changes going back as far as the 1970s. When S&P downgraded the U.S. government in August 2011, bonds rose and pushed Treasury yields down to records.

Sanctions Impact

Putin said yesterday that sanctions aren’t having a “critical” impact on the country. He called on Ukraine to halt an offensive against pro-Russian separatists after troops entered the eastern city of Slovyansk, killing five rebels. Using the army against civilians would “have consequences for the people who make such decisions,” Putin told reporters in St. Petersburg.

Consumer-price growth accelerated to 6.9 percent in March from year earlier after reaching 6.2 percent in February. Inflation may be 5 percent to 6 percent in 2014, central bank Chairman Elvira Nabiullina said March 27, compared with the regulator’s 5 percent target this year. It missed its target range of 5 percent to 6 percent in 2013.

Inflation may peak in May or June at 7.5 percent, Maxim Oreshkin, head of the Finance Ministry’s strategic planning department, told reporters April 21. Speaking during an annual televised call-in show last week, Putin said he hoped the central bank could keep inflation at 6 percent to 6.5 percent.

Prices vaulted past issues in housing and utilities to become the biggest problem for Russians, according to a poll published April 14 by the state-run All-Russia Center for the Study of Public Opinion.

“The central bank somewhat overestimates that inflation will be at 6 percent by the end of the year and that the current dynamics could hurt inflation expectations,” Oleg Kouzmin, chief Russian economist at Renaissance Capital and a former monetary policy adviser at Russia’s central bank, said by phone today. “Today’s decision is obviously negative for the markets.”

To contact the reporters on this story: Anna Andrianova in Moscow at aandrianova@bloomberg.net; Olga Tanas in Moscow at otanas@bloomberg.net; Ksenia Galouchko in Moscow at kgalouchko1@bloomberg.net

To contact the editors responsible for this story: Balazs Penz at bpenz@bloomberg.net Paul Abelsky


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