Russian Central Bank steps in to cut key interest rate again

Russian Central bank cut its key interest rate by 0.5 percentage points to 11 percent, bowing to the pressure of businesses to make lending more accessible. Source: AP

Russian Central bank cut its key interest rate by 0.5 percentage points to 11 percent, bowing to the pressure of businesses to make lending more accessible. Source: AP

The Russian Central Bank has lowered the key interest rate to 11 percent. By doing so the Russian government is trying to improve the investment climate in the country. However, experts believe the move is a compromise – a drastic slashing of the rate would result in a spike in inflation, which has already reached 15.8 percent.

The Russian Central Bank – the main regulator of the country's financial market – has decided to lower the key interest rate by 0.5 percent to 11 percent.

The Central Bank’s press office, explaining the move on July 31, pointed out that a high key rate makes credit for business more expensive, which has a negative impact on the investment climate in Russia. However, the lowering of the key rate and an increase in the issue of credit by banks leads to a rise in inflation, which as of July is 15 percent in Russia. Moreover, immediately after a rate cut the value of the ruble starts to fall.

"The balance of risks is again leaning towards the real cooling of the economy, despite some increase of inflation risks," says the Central Bank announcement.

The key interest rate influences the interest with which banks give credit to businesses and private individuals, which traditionally cannot be lower than the key interest rate.


A compromise

Konstantin Korischenko, deputy director of the Capital Markets and Financial Engineering Department at the Russian Presidential Academy of National Economy and Public Administration (and former deputy chairman of the Central Bank) explains that the decision to lower the key rate by a symbolic 0.5 percent is a compromise.

On the one hand, the remaining risks of inflation and the devaluating ruble do not allow for the bank to lower the rate any further. On the other hand, the deceleration of the Russian economy demands active, stimulatory measures such as, firstly, the provision of cheaper credit resources.

"Cutting the key rate is a continuation of the Central Bank's policy of attenuating its credit-monetary policy, something that will make credit resources more accessible and thus stimulate the development of the Russian economy," said Alexei Kozlov, chief analyst at the UFS investment firm.

Yet Kozlov pointed out that at the same time, with the ruble unstable, the Central Bank must maintain a balance between the need to stimulate the growth of the economy and the possibility of lowering the key rate.

According to Finam Holding analyst Anton Soroko, essentially the Central Bank is trying to stimulate the real sector of the economy.

“This decision was largely dictated by the worsening situation of raw materials and the consequent weakening of the ruble, and not by good results in the restoration of business activity," said Soroko. Annual inflation is still at a high level and GDP continues to fall, while oil prices are at a record low – $52.5 a barrel.


The main consequences

Earlier, at the end of 2014, the Russian Central Bank sharply increased the key rate from 9.5 to 17 percent in order to "freeze" the issuing of credit in the country and stop the demand for foreign currency. The decision was preceded by a 50-percent fall in value of the ruble against the dollar and euro. Afterwards the regulator gradually lowered the rate in order not to provoke inflation.

"The pace that was achieved in the beginning of the year was impressive. It was due to the sharp hike of the key rate in December 2014, as well as the relative stabilization of the ruble and the weakening of inflation pressure,” said Alexei Kozlov.

However, in Kozlov's view, the future dynamic of the key rate will largely depend on external factors, mainly on the stability of oil prices, since it is they that principally determine the stability of the ruble.

Significant changes in the markets and the economy should not be expected, said Konstantin Korischenko.

"The influence of the oil prices, the sanctions war and the ongoing shortage of money in the economy is unlikely to lead to a change in today's growth, inflation and ruble value trends," he said.

According to Anton Soroko, meanwhile, the Central Bank will continue attenuating its credit-monetary policy in its future sessions and by the end of the year the key rate will be around 8.5-9.5 percent.

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