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Published: Friday July 25, 2014 MYT 9:15:02 PM
Updated: Friday July 25, 2014 MYT 9:16:03 PM

Russia raises rates in move seen as arming for sanctions

MOSCOW (Reuters) - The Russian central bank unexpectedly raised interest rates on Friday, apparently preparing for possible further Western sanctions over Ukraine that could speed up capital flight from Moscow's already battered markets.

The 28-nation EU has warned it may curb Russian access to capital markets, arms and energy technology in response to last week's downing of a Malaysian airliner in an area of eastern Ukraine held by Russian-backed separatists.

The central bank, in one of its most hawkish decisions in recent years, said the 50-basis points rate hike was governed by concerns about high inflation and geopolitical tensions - an apparent reference to Ukraine.

"Inflation risks have increased due to a combination of factors, including, inter alia, the aggravation of geopolitical tension and its potential impact on the rouble exchange rate dynamics," the central bank said in a statement.

The $2 trillion economy is flirting with recession, recording zero growth in the second quarter, the rouble remains shaky and capital flight has already hit $75 billion this year.

"This has nothing to do with inflation - with the economy failing to fire, the central bank should be cutting rates," said Timothy Ash, head of emerging markets strategy at Standard Bank in London.

"This is more to do with the central bank raising the defences on the assumption that further Western sanctions are going to follow, hiking capital flight and likely putting downward pressure on the rouble.

The bank's decision brings the central policy rate, the one-week minimum auction repo rate, to 8.0 percent, after cumulative rate hikes of 200 basis points in March and April when the rouble and stocks tumbled after the first wave of Western sanctions on Moscow for the annexation of Ukraine's Crimea.

"I counted three mentions of the word geopolitical in the central bank statement, I think we can read something into that," said Neil Shearing, chief emerging markets economist at Capital Economics in London.

THE MUDDY FUTURE

The decision to raise rates is seen as another headwind for domestic investment activity, as it makes borrowing more expensive, and dampens gross domestic product growth, which most analysts envisage at barely above zero this year.

But it shows the risks and the price Russia is paying for continued involvement in the Ukrainian conflict, with investment by domestic firms already in decline for most of recent months.

Government officials rushed to describe the sanctions impact as "peanuts," but former Finance Minister Alexei Kudrin, esteemed by investors, warned this week Russia had already lost 1 percent GDP growth and might lose more in coming years.

"Russia is yet to choose its decision, which it will announce to the world in regard to settling the conflict in Ukraine," Kudrin said in a rare criticism of the conservative policies of the Kremlin.

The rouble, which lost 10 percent against the dollar earlier in the year but since recovered, firmed briefly on the central bank's decision, but later traded down 0.2 percent on the day. Stocks on rouble-denominated MICEX were down 1.5 percent, losing 2.5 percent this week.

"The move is marginally supportive for the rouble, even though it won't be able to stop foreign capital repatriation if bolder sanctions are approved, while reignited pressure from potential household demand for hard currency would only be addressed if banks continue raising their deposit rates," Dmitry Polevoy, chief economist at ING in Moscow, said in a note.

The rouble's spring decline contributed 0.8 of a percentage point to annual inflation, which remains the main worry for President Vladimir Putin's electorate, according to opinion polls.

Inflation hit 7.8 percent in June - well above the central banks' forecast of up to 6.5 percent for the whole of 2014.

"If high inflation risks persist, the Bank of Russia will continue raising the key rate,” the central bank said.

"Basically ... we can expect the key rate to go higher if new risks materialise (for, example, introduction of level III sanctions on Russia and the rouble getting seriously hit), which is not beyond imagination," analysts at Gazprombank said in a note.

The decision indicates Russia is preparing for what may lie ahead, analysts said. "Maybe the central bank has been given the nod by their political masters in the Kremlin that this crisis is still going to get worse before it gets better," Ash, of Standard Bank said.

(Additional reporting by Oksana Kobzeva, Elena Orekhova, Vladimir Abramov, Dasha Korsunskay; Writing by Lidia Kelly; Editing by Timothy Heirtage and Philippa Fletcher)

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