Central Bank Raises Its Rates to Curb Prices

The Central Bank raised all its interest rates by 25 basis points to curb inflation on Monday as capital inflows resumed and fears of a liquidity crunch in the financial sector receded.

The bank said it had raised the floor for its one-day repo rate, at which commercial banks receive liquidity through repo operations -- the Central Bank's main refinancing tool -- to 6.5 percent from 6.25 percent.

Central Bank first deputy chairman Alexei Ulyukayev said last week that the bank sees its interest rates as the primary weapon against inflation while the International Monetary Fund advised the country to tighten its monetary policy.

The Central Bank also raised its refinancing rate, which is rarely used in practice and serves as a ceiling for all official interest rates, to 10.5 percent from 10.25 percent. Short-term deposit rates were raised to 3.25 percent from 3.0 percent.

The Central Bank last raised its interest rates in a similar 25-basis-point move in February, but with inflation now running at 14 percent, over 2 percentage points above last year's level, real official interest rates remain deeply negative.

"At their current level, the impact of the interest rates on inflation is minimal. From the macroeconomic point of view, a more frequent or significant rise would have been more welcome," said Alexander Morozov from HSBC.

Finance Minister Alexei Kudrin said net capital inflows to Russia in April have resumed, reaching about $10 billion after $22 billion in outflows in the first quarter, compounding petrodollar inflows as a result of high oil prices.

Kudrin said the liquidity situation in the banking sector had stabilized after the banks successfully handled in April their clients' corporate tax payments, which drain huge amounts of cash from banks.

"We have enough cash, enough liquidity in the economy," Kudrin said, pointing to recently held short-term money market auctions to deposit budget cash in commercial banks, which showed little demand for extra cash outside the Central Bank's refinancing facilities.

A resumption of inflows allows the Central Bank to move on inflation without squeezing commercial banks, which have had difficulties tapping international capital markets in the global economic downturn.

With official interest rates setting a smoke screen, markets are now trying to guess whether the Central Bank will use its heavy artillery -- the appreciation of the ruble and a rise in mandatory reserve requirements -- and analysts are divided.

Currency dealers tested the Central Bank's bid level this month, selling about $25 billion to the regulator. The Central Bank bought the dollars but changed its rhetoric with Ulyukayev saying he no longer ruled out appreciation.

Goldman Sachs analysts expect the Central Bank, which runs a managed float of the ruble against the currency basket, to allow the ruble to strengthen by 2 percent in the next three months and another 2 percent in the three months to follow.

Many other ruble watchers do not share this view and expect the Central Bank to continue raising interest rates or mandatory reserve requirements as the stronger ruble will slow economic growth and benefit carry traders.