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. Last Updated: 07/27/2016

Central Bank Raises Interest Rates

After last week's auction that set new benchmark interest rates on the money market, the Central Bank raised interest rates on commercial banks' deposits by 0.5 to 2 percentage points.

By doing so, the Central Bank clearly showed its preference for a strong ruble, which traders did not expect to dip below 28 rubles to the dollar by year-end even without intervention by the bank.

The Central Bank has steadily reduced interest rates paid on deposits of commercial banks this year. This, in theory, should have stimulated the banks' lending activities. Since the beginning of the year the yield on deposits with three-month maturity has fallen from 20 percent to 9 percent while overnight rates have fallen from 3 percent to 1 percent.

In an auction held last week for banks without access to Reuters-Dealing, the Central Bank paid above the market interest rates.

This week the Central Bank jacked up yields on deposits to the same level. The Central Bank pays 5 percent on weekly deposits, 6.5 percent on 14-day deposits and 8 percent on monthly deposits.

Tatyana Paramonova, deputy head of the Central Bank, said "in the future [the Central Bank] will consider the possibility of equating [different] rates" on the money market. However, the Central Bank does not plan to pay a premium on deposits.

Market participants say the increased Central Bank rates are indicative only.

The bank will show the market "which way it should think," said Sergei Monin, head of Raiffaizenbank's treasury department. By soaking up ruble liquidity the Central Bank weakens the dollar, he said.

Traders expect high oil prices to sustain slow ruble devaluation.

Monin suggested the ruble will appreciate against the dollar toward the end of the year. Traditionally banks dump dollars and buy rubles before closing their books at year-end.

Gleb Sorokin, of MFK Bank, said it is hard to tap the ruble market at this time since the banks are reluctant to "place deposits that mature next year."

Sorokin said the 28 ruble-to-the-dollar exchange rate constitutes "a high level of resistance" and that the ruble will not become more expensive toward the end of the year.

Dmitry Monastyrenko, of the Trust and Investment Bank, said the market does not expect the ruble to top 28 rubles per dollar since whenever the bulls step in "the Central Bank appears and scares them away," he commented.

Fundamentally, the ruble remains undervalued and could further strengthen, said Oksana Osipova, expert at the Growth Center.

However, traders fear that the International Monetary Fund will not resume its lending program and the government will have to purchase hard currency in order to pay the Paris Club creditors, Osipova said.

The government has earmarked $3.2 billion for Paris Club creditors in its 2001 draft budget.

The ruble is unlikely to strengthen without a restructuring deal with the Paris Club.

"The demand for ruble assets evaporated by the end of the summer," Osipova said.

She forecast that the seasonal demand in January for hard currency would not lead to the traditional fall in the ruble. The trade surplus in December could come to $6.5 billion to $7 billion "so there is no reason to expect volatility on the forex market," she said.

Since oil prices will likely stay high at least until the middle of next year, traders expect slow ruble devaluation.

"Next year the dollar will appreciate by 20 kopeks per month," predicted Gennady Vagabov of MDM Bank.