Russia Surprises Markets With First Rate Hike Since 2014

With market watchers expecting no moves from the Russian central bank today, and just one week after Russia's PM Dmitry Medvedev hinted that Russian rates are "too high", the Russian central bank became the latest to defy politicians - and consensus - when it unexpectedly hiked interest rates for the first time since 2014, following many other emerging market peers who have been forced to tighten in response to the Fed, as inflation risks mount with a slumping currency and threats of U.S. sanctions.

Russia's benchmark was raised by 25bps to 7.5% from 7.25% with only two of 42 economists expecting an increase, and 40 calling for no change. Russian central bankers said they will also "consider the necessity of further increases." At 3pm Moscow Time, central bank governor Elvira Nabiullina will hold a news conference followed by the release of the latest economic  forecasts.

With today's surprise hike, the Bank of Russia reversed four years of monetary easing, ending a pause that started after U.S. sanctions in April sent markets into a nosedive and revived risks for inflation according to Bloomberg.

Even though Turkey’s decision a day earlier to raise rates more than expected took some of the heat off Russia to follow suit, Nabiullina opted for a hike despite appeals from top government officials before the meeting. A Kremlin economic aide called such a move “highly undesirable.”

"Given what’s happening in the markets, investors expect some reaction - a combination of concrete actions and words was needed,” Valeriy Vaysberg, head of research at Region Investment Co., told Bloomberg before announcement. "A small rate increase and tight rhetoric provide such a balance."

Commenting on the move, BlueBay's FX strategist Timothy Ash said that it was all about Moscow's response to crippling US sanctions: "Russia - against consensus (albeit i expected) CBR hikes base rate 25bps, following the lead from Turkey (minus 600bps). All about providing a geopolitical underpinning for the rouble given looming sanctions risks."

That, and of course, inflation: the central bank has estimated that each 10% decline in the ruble could add 1% to inflation. Inflation expectations among households, which the central bank calls a “pillar” of its rate decisions, already rose in August to 9.9 percent, more than triple the current inflation rate and the highest reading in almost a year.

The ruble has lost more than 8% since the end of July, when the central bank last reviewed rates, although it appreciated against the dollar - which suffered its biggest drop since February - for much of this week. It rallied after the rate announcement, trading 0.6 percent stronger as of 1:33 p.m. in Moscow. The Russian currency’s one-month implied volatility is among the highest globally.

Commenting on the move, Bloomberg's Stephen Kirkland said that the hike will bolster the ruble, "which is already benefiting from higher oil prices and an improving fundamental story." And while the rate hike hasn't produced the same degree of currency gains and EM read across compared with Turkey's tightening yesterday, it "does signal central banks are increasingly focused on inflation and are taking steps to defend their currencies."

And since tighter financial conditions across the rest of the world also assure a continued economic slowdown, it remains up to the Fed to decide just how much economic risk the US central bank is willing to take from abroad before telegraphing that the Fed's own tightening cycle is nearing its own end.