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. Last Updated: 07/27/2016

Drought May Prompt Interest Rate Hike

MTEconomists say heat-related inflation may force the Central Bank to react.

The Central Bank may raise interest rates this year to contain inflationary pressure should a worsening drought hit farm output in Europe's leading wheat producer, economists said Friday.

Soaring temperatures across large swathes of Russia since late June have destroyed nearly 10 million hectares of crops and have already cost the agricultural sector about $1 billion.

With meteorologists forecasting at least another 10 days of drought and heat, economists expect the price of vegetables, fruits and grains to rise inside Russia itself, and some are beginning to ask whether the Central Bank will raise interest rates before year-end to meet its inflation targets.

"So far, there are no grounds to review the 2010 inflation target," Deputy Economic Development Minister Andrei Klepach said.

The government's inflation target is 6 to 7 percent, but Central Bank officials have pledged to keep the consumer price index rate below 6 percent this year. Prices have so far risen 4.6 percent since the start of the year, including gains of 0.1 percent for each of the past two weeks.

August and September are months when Russian inflation typically slows because of abundant supplies of crops, but key grain-producing regions have seen temperatures above 30 degrees Celsius for several weeks.

"I think it will be an important subject. If such weather stays for a couple of weeks, [a hike in rates] will be quite likely," said Natalya Orlova, chief economist at Alfa Bank. She forecast 2010 CPI of 7 percent.

"Money market rates already tend to grow, and the Central Bank is likely to decide to hike rates by the year-end," she said.

Vladimir Osakovsky, chief economist at UniCredit in Moscow, said drought-driven inflationary risks increased the probability of higher interest rates closer to year-end.

Before taking a break in June, the Central Bank had cut interest rates 14 times since April 2009, bringing them to record lows to revive domestic lending and ease speculative pressure on the ruble.

Some economists, however, doubted that a drop in Russia's farm goods output would significantly increase inflation because existing inventories and other sources can meet demand.

"It's not inevitable that inflationary risks will arise. If we see low stocks, imports will inch up," said Yevgeny Gavrilenkov, chief economist at Troika Dialog. He forecasts inflation at 5.5 percent to 6.0 percent.

While grain prices and bread prices tend to move together, the link has started to break, industry experts said.

Wheat now represents about 10 percent of bread's production cost, compared with around 23 percent 18 months ago, said Alexander Zlochevsky, president of the Russian Grain Union.

"If bread bakers start to raise prices now, it would be unjustified," he said.

Flour prices have jumped 25 percent over the past two weeks to 9 rubles (30 cents) per kilogram, said Andrei Gurov, chief executive of macaroni producer Infolink. Prices for macaroni have risen accordingly because flour represents 75 percent to 80 percent of the total production cost, he said.

"It's all nerves about how the Volga region has been on fire," Gurov said. "Soon the picture will be more objective."

(Reuters, Vedomosti)