Russia Unexpectedly Hikes Key Rate On Higher Inflation Risks; S&P Cuts Rating

(RTTNews) - Russia's central bank raised the main interest rate on Friday in a surprise move, citing a substantial increase in inflation risks amid the escalating tensions over Ukraine that hurt the economy and attracted a rating downgrade.

The Board of Directors decided to raise the key rate to 7.5 percent per annum due to higher inflation risks, the Bank of Russia said in a statement. Economists had expected the bank to leave rates unchanged this month.

"The probability of inflation exceeding the 5 percent target at the end of 2014 has increased substantially," the bank said today.

"This has been caused by more pronounced than expected pass-through effect of the exchange rate dynamics on consumer prices, the rise in inflation expectations, as well as unfavorable conditions in the markets for some goods."

Further, the bank asserted that it does not intend to lower the key rate in the coming months and expects the latest hike to ensure the decline in inflation to no more than 6 percent by the end of 2014. The central bank's inflation target range is 5 percent to 6 percent.

"With inflation likely to remain high and the ruble vulnerable to a further escalation in tensions in Ukraine, monetary conditions are set to remain tight for the foreseeable future," Capital Economics Emerging Markets Economist Liza Ermolenko said.

"A pick-up in capital flight on the back of the crisis in Ukraine could cause the Bank to hike rates even further."

On March 14, the bank left rates steady after announcing a massive 150 basis points hike earlier in the month. The rate raise came after President Vladimir Putin secured parliamentary approval to deploy troops in Ukraine's autonomous region of Crimea.

The acceleration in inflation is mainly due to a weaker ruble, the bank said. Russia's core inflation climbed to 6 percent in March from 5.6 percent in February, while the headline figure is estimated to have reached 7.2 percent as on April 21, the bank added.

Earlier today, rating agency Standard & Poor's cut Russia's credit rating to 'BBB-' from 'BBB' on Friday, citing the risk of marked deterioration in external financing.

The downgrade comes amid an escalation in the Ukraine crisis. S&P last lowered Russia's rating in December 2008.

The agency said the outlook on the country's ratings remains negative. Further, S&P said the negative outlook reflects its view that Russia's ratings could be lowered over the next two years if there is an increase in the risks to the country's creditworthiness.

"Today's downgrade reflects the risk we perceive of a continuation of the large financial outflows observed in the first quarter of 2014, during which the size of Russia's financial account deficit was almost twice that of the current account surplus," S&P said in a statement.

S&P also cautioned that the tense geopolitical situation between Russia and Ukraine could see additional significant outflows of both foreign and domestic capital from the Russian economy and hence further undermine already weakening growth prospects.

"The current economic slowdown is predominantly structural by nature and thus does not exert any noticeable downward pressure on inflation," the central bank said today. The economy grew just 0.8 percent year-on-year in the first quarter.