Russian central bank steps up the pace
Today’s interest rate cut is larger than expected but likely to have limited impact on the strength of the rouble.
In a surprise move, the Russian central bank cut interest rates by 50 basis points (bps) instead of the smaller 25 bps cut expected by the market.
However, this seems not to signal a deeper cycle; in a statement the bank said its assessment of the overall potential for easing is unchanged, suggesting it has simply brought cuts forward.
Cut supported by lower inflation
There was a suggestion that the bank’s deeper-than-expected cut is a response to Russian President Putin’s comments earlier this week that the government was looking for ways to weaken the exchange rate.
Currency strength is unhelpful for exporters and fiscal revenues from oil, but does assist with hitting an inflation target of 4%.
CPI (the consumer price index) seems to be well on its way to that target, currently at 4.3%, which has given the central bank confidence to cut more aggressively in support of growth.
Central bank still independent
We do not buy into the idea that the bank’s independence has been compromised by government exchange rate targets. If the concern is that investors seeking carry1 are driving rouble strength, and the market already expects rates to drop to 8.5% by year end, a compromised central bank would indicate a lower end point for rates rather than just frontloading cuts.
In any event, the cut has done little to drive investors out of the rouble, which is somewhat stronger following the move.
Limited impact on currency strength
Our own expectation for rates this year remains unchanged at 8.5% by year-end. Given the low yield environment which persists globally, it seems unlikely that the central bank would be able to reduce rouble carry sufficiently to significantly weaken the currency.
The main risks to this view would be a much more aggressive Federal Reserve, which would narrow the rate differential and strengthen the dollar, or a collapse in the oil price, though this would presumably deliver the rouble weakness central government desires.
1. A carry trade is a strategy in which an investor borrows money at a low interest rate in order to invest in an asset that is likely to provide a higher return.↩