Russia's central bank maintained its key rate at 7.50 percent but said inflation this year was "unlikely" to slow to its target and warned that it would raise rates further if its medium-term inflation target is threatened by an additional decline in the ruble's exchange rate, higher food prices, administered prices or inflation expectations.
The Bank of Russia, which has already raised its rate by 200 basis points this year, also revised down its 2014 growth forecast to 0.4 percent from 2013's growth of 1.3 percent.
Last month the bank's governor, Elvira Nabiullina, said the forecast would probably be revised down to 0.5 percent after it said in April that growth would probably be less than 1.0 percent due to the impact of the conflict with Ukraine and emerging market uncertainty.
The central bank said the depreciation of the ruble in late 2013 and early 2014 would continue to have a negative affect on consumer prices in coming months and the ongoing economic slowdown is not having a major restraining effect on inflation as it is caused by structural factors.
Russia's headline inflation rate rose to 7.6 percent in May, the fastest pace since 2011, and well above the central bank's 5.0 percent target for this year. The central bank, which is moving to an inflation-targeting regime, targets 4.5 percent inflation in 2015 and 4.0 percent in 2016.
In April, when the bank raised its rate for the second time this year, the central bank said the probability of inflation exceeding its 2014 target had risen substantially but past rate rises should ensure that inflation declines to a maximum of 6.0 percent by end-2014.
While the central bank said its current monetary policy stance should ensure that inflation slows to its medium-term targets, it acknowledged a high risk that inflation would exceed its targets.
"That risk is related to ruble exchange rate dynamics affected by, inter alia, monetary policy measures of the foreign central banks and the geopolitical situation," the bank said.
Russia's ruble started falling against the U.S. dollar in February 2013 but the decline accelerated sharply in January this year, along with many other emerging market currencies, as investors began shifting their portfolios in anticipation of the U.S. Federal Reserve's reduction in asset purchases.
The conflict with Ukraine then sparked a further decline in the exchange rate in March as the outflow of capital from Russia picked up speed, hitting US$ 50.6 billion in the first quarter.
But since early May the decline in the ruble has reversed, with the ruble quoted at 34.62 to the dollar today, up from a low of 36.9 in March. But the ruble is still down 5.2 percent against the dollar since the start of the year.
But the stabilization of the ruble in the last month should improve the inflationary outlook along with lower planned increases in administered prices in the second half, low demand pressure and a good harvest. Low inflation will then tend to reduce inflation expectations, the bank said.
A lower exchange rate tends to make a country's exports more internationally competitive, but the central bank said any boost from the lower ruble will be limited amidst economic uncertainty and falling producer confidence that will likely lead to lower investment.
In addition, the combination of a slowdown in the growth of wages and a fall in households' lending rates will dampen consumer activity.
"Labour productivity growth is sluggish, while fixed capital investment continues to contract because of declining profits in the real sector, limited access to long-term financing in both international and domestic markets as well as low producer and consumer confidence," the bank said.
Russia's Gross Domestic Product contracted by 0.50 percent in the first quarter of this year from the previous quarter for annual growth of only 0.9 percent, down from 2.0 percent.
At the same time, inflation is accelerating, mainly due to the impact of a lower ruble on import prices, raising household inflation expectations.
"Uncertainty about the international political situation also hampers production and investment," the central bank said, adding weak economic activity in trading partners is also restraining growth.
Economic growth is expected to accelerate slightly in the second half of this year due to lower geopolitical tensions, improving sentiment among producers and better exports.
www.CentralBankNews.info
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