Rouble's surge gives green light for Russia to slash rates

Moscow

A RALLY in the rouble may mean Russia's central bank has room to cut interest rates even deeper than the full percentage point it has already committed to.

The currency's surge with oil prices this quarter, coupled with a slump in consumer demand due to the coronavirus lockdown, will likely prevent inflation from accelerating above the central bank's 4 per cent target any time soon. Analysts at some of Wall Street's biggest banks say more than 2 percentage points of cuts are possible.

"Inflation is clearly not going to 4 per cent," said Clemens Grafe, an analyst at Goldman Sachs in Moscow. "If inflation surprises with an even lower path, then the key rate may be at 3.5 per cent already this year."

Bank of Russia governor Elvira Nabiullina is under pressure to slash borrowing costs to help stimulate an economy that's taken a double blow from the coronavirus lockdown and drop in oil demand. At her final news briefing on Friday before a rates decision on June 19, she reiterated that there is significant room to cut and a full percentage point reduction to 4.5 per cent is on the agenda.

"We prefer moving gradually so that all economic parties can adapt to the situation," Ms Nabiullina said when asked if the central bank would consider a bigger reduction this month. Cutting too fast could put banks at risk, and the economic situation might change, she said, adding that Russia isn't likely to experience a V-shaped recovery.

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Bets of bigger rate cuts have given a boost to Russian government bonds, which have handed dollar investors returns of 21 per cent this quarter, one of the best performances in emerging markets.

Ms Nabiullina said on Friday that inflation is coming down faster than expected and will continue to do so. Annual price growth eased to 3 per cent in May from from 3.1 per cent in April, matching economist estimates, the Federal Statistics Service reported Friday.

Economists at Citibank in Moscow said last month that Russia could end up cutting rates to as low as 3 per cent, without specifying timing. Bank of America Merrill Lynch is forecasting 3.5 per cent, while Deutsche Bank says 4 per cent is the lowest it could get in the current easing cycle. Ms Nabiullina declined to say what the year-end target for rates is.

Piotr Matys, a strategist at Rabobank in London, says the size of the rate cut may depend on how far the rally in the rouble extends. If the currency erases its sell-off from the collapse in oil prices in March, climbing to 65 versus the dollar, from about 69 now, the central bank will opt for a larger reduction, he said.

"When your economy is in a recession and you rely on external demand for commodities, the last thing you want is for your currency to appreciate," Mr Matys said. BLOOMBERG