Despite Rate Hike, Russian Ruble Slumps To New Record Low

Despite a 100bps rate hike this morning, Russia’s Ruble has slipped lower and now trades 55.8 to the USD – a new record low. The initial surge in the Ruble was quickly sold back as the hike, while in line with surveyed expectations, was below FRA-market-implied levels of 200bps. Goldman believes this will not slow the decline and calls for ‘other tools’ like unsterlized intervention. Russian default risk continues to rise (though still low) back to the highest since April 2009.

From FX interventions to rate hikes, nothing appears to be slowing the collapse…

But today’s rate hike gains very rapidly diminished…

As Goldman explains, this may not be enough…

The CBR raised its main policy rate by 100bp, below market expectations for as much as a 200bp rate hike, but above our forecast for 50bp. In our view, the decision was guided by inflation and inflation expectations dynamics, which have worsened markedly in recent months. The CBR noted that it expects inflation to rise to 10% by year-end and to stay close to this level into Q1-2015, before beginning to decline in Q2 and into H2-2015 – a forecast that is very similar to ours. It indicated that it will maintain a tightening bias in case inflation dynamics worsen further, but will begin easing policy once inflation stabilizes and is on a downward trend. We maintain our view that the CBR will keep rates on hold in Q1-2015, before entering into a rate-cutting cycle in Q2 as inflation begins declining.

In our view, the CBR will continue to adjust policy rates in response to developments in inflation and inflation expectations, while potentially using other tools in order to stabilize the Ruble. These other tools include FX interventions that may be unsterilized and, thus, tighten liquidity, with the CBR limiting the quantities offered at its main lending facilities.

Key numbers

Key rate (7-day auction-based repo): 10.5%, up from 9.5% previously (GS: 10.0%; consensus: 10.5%)

Main points

The Bank of Russia raised its main policy rates by 100bp, above our forecast for a 50bp hike but below market expectations for a larger rate hike, with FRA contracts implying expectations for short-rates to rise by 200bp. The immediate market reaction – a 1% weakening of the Ruble and a 15-50bp decline in yields at different tenors of the bond curve and a sharply lower move in front-end swaps – confirms that the decision was a disappointment to market expectations for a larger hike. Nonetheless, the rate hike was in line with the Bloomberg survey median expectation for a 100bp rate hike.

As usual, the press statement placed most of its emphasis on inflation dynamics, which it cited as the main reason for the rate hike. It noted that inflation was running at 9.4% as of December 8, with Rosstat’s measure of core inflation running at 8.9% in November. It indicated that the CBR’s forecast is for inflation to rise to around 10% at end-year and then possibly to exceed 10% in Q1-2015, before declining later in the year as pass-through from the weaker Ruble fades, with downward pressure from subdued aggregate demand (due to an output gap), and with base effects from this year’s food import bans. The statement also referred to a “surge” in inflation expectations among households and firms.

The press statement reiterates the CBR’s view that the current monetary stance is intended to reduce inflation to the target level of 4% in the medium term. However, there was no reference to the 2015/16 inflation targets, which had been dropped explicitly in the CBR’s recently-published monetary policy guidelines for 2015-17.

The statement indicated that the CBR expects growth to be close to zero in 2015-16, before recovering in 2017. However, the CBR does not see much spare capacity on the supply side and sees investment contracting next year and consumption remaining weak.

The CBR indicated that it will maintain a tightening bias in case inflation risks worsen. However, it also stated that in the presence of a “stable downward trend” in inflation and inflation expectations, it will start easing monetary policy.

Our forecast for inflation is very much in line with the CBR’s. We forecast that it will rise further to 9.7% at year-end and will stand close to 10% in Q1-2015, before beginning to decline in Q2 and into H2-2015. Assuming this inflation forecast, we maintain our view that the CBR will keep rates on hold into Q1-2015 and will begin cutting rates in Q2 as inflation begins falling.

We think that the CBR will continue to adjust policy rates in response to developments in inflation and inflation expectations, while potentially using other tools in order to stabilize the recent Ruble volatility. These other tools include interventions that may be unsterilized and, thus, tighten liquidity, with the CBR limiting the quantities offered at the CBR’s main lending facilities.

* * *

Russia default risk – although still relatively low – has spiked recently to its highest since April 2009…