<

Russia on collision course with inflation after leaving rates unchanged

Russian Inflation and Inflation Rate  2013-04-11Enlarge Graph

The Russian Central Bank (RCB) decided to leave its key rates unchanged despite inflation clearly out of the 5-6% target range.

RCB maintains rates

The dovish1 standpoint surprised the market, yet it was no celebration. In general, markets rally when interest rates are cut since the lower cost of debt should promote growth in an economy. The concern this time is that the RBC is not reigning in inflation, and the Russian Ruble has depreciated as investors lose faith in the currency.

The RCB blamed inflation on food prices and regulated tariff growth and, therefore, did not take action to stop it. The RCB stated that it does not expect the consumer inflation to drop to the target range until the second half of 2013. Additionally, it pointed towards reduced economic growth and higher risks of further deceleration in the economy.

Market reaction

A depreciating Ruble hurts the returns for foreign investors, hence the market reacted negatively. The Ruble depreciated approximately 1.6% thus far this week; the MSCI Russia Index fell 0.3%. Foreign investors in RSX, an ETF tracking the large cap stocks of the Russian equities market, saw the share price drop over 2%.

Russian Ruble to USD FX Rate 2013-04-11Enlarge Graph

Implications

The resulting inflationary pressures will likely further depreciate the Ruble, which will increase currency losses for international investors. Additionally, the surprise inaction towards inflation makes it more likely that Russia will cut rates on their upcoming meetings, rather than increase them to control inflation.

Interest rate cuts down the line will fuel inflation expectations which will lead to unsustainable growth. The rate cuts could provide some growth, but from an international investor point of view the foreign exchange risk may not be worth the try.

  1. Dovish: favoring lower interest rates