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. Last Updated: 07/27/2016

Markets Tick Up on Repo Rate Increases

Markets reacted calmly Monday to the Central Bank's decision to raise interest rates and reserve requirements, and analysts said the bank was bound to use the ruble exchange rate to defeat inflation.

The MICEX Index ticked up for a second day Monday, adding 2.3 percent to 1,677.78 in Moscow as all but three of its 30 stocks advanced. The RTS Index increased 2.2 percent to 2,012.76.

The Central Bank raised the floor for its key one-day repo rate by 25 basis points to 6.25 percent, and increased reserve requirements on ruble retail deposits by 50 basis points and on foreign currency liabilities by 1 percentage point.

Central Bank deputy head Gennady Melikyan said the decision showed that policy makers were committed to bringing inflation under control. "The main thing is that we send a signal to everyone, to the commercial banks, financial structures, everyone that is working on the market, that we are serious about this issue," Melikyan told Vesti state television.

Melikyan acknowledged that there could be problems with liquidity were the situation on markets to "develop unfavorably."

"Nonetheless we see the dangers connected with inflation and are sending a signal to everyone," he said. "Friends, this is the responsibility of the government and the Central Bank, and we aren't joking."

Markets saw Friday's decision as a blow to the country's banks, which are still recovering from a severe liquidity shortage, but the government's recent cash injections appeared to have helped them to withstand the increases.

"The measures will not negatively affect the banking system. The Central Bank is not worried about the liquidity situation," Central Bank board member Alexei Simanovsky told reporters.

Money market interest rates remained at 2 percent to 3 percent, well below the repo rate, while the amount of cash commercial banks had on deposit at the Central Bank rose 15 percent to 331 billion rubles ($13.5 billion) after the deposit-rate increase.

Demand for liquidity was weak at the first one-day repo auction with the new repo rate floor, with banks taking a mere 111 million rubles ($4.5 million) from the Central Bank at 6.25 percent.

"The decision to increase the repo rate is a serious indication that, despite all the international volatility, the Russian banking sector remains in very good shape," Alfa Bank analyst Natalya Orlova said.

Simanovsky said the rise in reserve requirements from March 1 coupled with a rise in the averaging ratio, which allows the banks to spread their reserves over time, would drain 20 billion rubles ($819 million) from the system, which was not critical.

The authorities' resolve in dealing with the liquidity shortage led markets to believe that the bank had prioritized liquidity management over inflation control, so Friday's move took markets by surprise.

In March, commercial banks face more debt redemptions and corporate tax payments, which may tighten liquidity, but the government said it was ready to place part of its bulging budget surplus on deposits in commercial banks as a safety cushion.

The exchange rate remains a major weapon in controlling prices and the ruble remained stable against the bank's dollar-euro currency basket Monday.

"We continue to see ruble appreciation as one of the few anti-inflationary tools that may be used without great detriment to liquidity," Deutsche Bank analyst Yaroslav Lissovolik said.