Russia's Central Bank Faces Inflation Battle as Rate Hike Looms

Russia's central bank is expected to implement a significant interest rate hike this week as inflation continues to plague the war-torn economy, reports CNBC. The move comes as the consumer price index (CPI) reached 8.9% in November, up from 8.5% in October, driven primarily by rising food prices.

The ruble's weakening, exacerbated by recent U.S. sanctions, has further fueled inflationary pressures. The sanctions, targeting Russia's Gazprombank, aim to hinder Russia's ability to finance military operations and have contributed to the ruble's decline to its lowest level since March 2022.

Economists anticipate a 200 basis point rate hike at the central bank's December 20 meeting, bringing the key interest rate to 23%.

"The renewed acceleration in Russian inflation to 8.9% year-on-year in November, and likelihood of further increases in the coming months, argue strongly in favour of another large interest rate hike from the central bank," stated Liam Peach, senior Emerging Markets economist at Capital Economics, in a note last week.

Peach warned that prices are likely to continue rising, with inflation potentially exceeding 9% by the end of 2025.

"With firms' price expectations also hitting new highs recently, there's a clear argument that the central bank is losing the battle against inflation and that it will be forced to hike rates sharply again... A 200 basis point rate hike is the base case in our view, but there are arguments in favour of a larger hike," Peach added.

The central bank previously enacted a 200 basis point rate hike in October, acknowledging that inflation was running "considerably above" its summer forecast and that inflationary expectations were on the rise.

"Growth in domestic demand is significantly outstripping the capabilities to expand the supply of goods and services," the CBR stated in a press release.

Russian consumers are facing particularly sharp price increases in basic foodstuffs, such as butter, eggs, sunflower oil, and vegetables, as demand outpaces supply. The war in Ukraine has also contributed to labor and supply shortages, driving up wages and production costs. The government, however, attributes the high cost of living to sanctions imposed by "unfriendly" countries.

The International Monetary Fund (IMF) predicts Russia will achieve 3.6% growth in 2024, followed by a deceleration to 1.3% in 2025. The IMF attributes this slowdown to a potential decline in private consumption and investment as the labor market tightens and wage growth slows.

While Russia has attempted to mitigate the impact of sanctions through import substitution and energy exports to willing countries, the international penalties are still having a negative effect.

The ruble's sharp depreciation against the dollar in November, following new U.S. sanctions, prompted the central bank to intervene and support the currency. The CBR announced that it would halt foreign purchases on the domestic currency market for the remainder of the year "in order to reduce the volatility of financial markets."

President Vladimir Putin, however, downplayed the concerns, stating that the situation is under control.

"There are absolutely no grounds for panic," Putin told reporters. "As for the fluctuations in the ruble exchange rate, this is connected not only with inflation processes, it is also connected with payments to the budget, it is connected with oil prices. There are many factors of a seasonal nature."

The ruble has since strengthened, but remains down approximately 3% against the dollar over the past month.

Analysts believe that the central bank's ability to combat inflation and the ruble's weakening is limited while the war persists.

"The fundamental reasons for the ruble's weakness have not gone anywhere, and the dynamic of Russia's trade flows means the currency is destined to falter and inflation to rise," wrote Alexandra Prokopenko and Alexander Kolyandr for Carnegie Politika. "As the Russian economy slows despite significant state spending, the dynamics of the ruble exchange rate suggest the country is heading for stagflation (a toxic combination of slow growth and rising prices)."