The RF Central Bank Perceives Recession As a More Serious Threat Than the Ruble's Depreciation

At the Bank of Russia Board of Directors' meeting on 11 December 2014, it was decided that the key interest rate should be raised dramatically - by 100 basis points to 10.5%. As stated in the Bank of Russia's information notice, the toughening monetary policy is aimed at playing down the inflation and depreciation expectations, which have been becoming increasingly stronger over the last few weeks.

True, the fall of the price of Brent crude oil from $ 85 to $ 65 per barrel had considerably increased the pressure on the ruble. At the same time, the core inflation rate rose to nearly 9%.

In our opinion, this decision of Russia's main financial regulator is aimed at finding a compromise. To curb the ruble's weakening, a decisively tougher policy is needed. So far, it has been by far insufficient just to raise the interest rate by 1% in order to stabilize the ruble's exchange rate. However, at present the Bank of Russia is not ready to resort to tougher measures, because it believes that such a solution is fraught with a much stronger probability of recession.

Besides, the ruble's weakening has been caused, among other things, by some fundamental factors like plummeting oil prices and massive-scale capital outflow. In such conditions, a declining exchange rate of the ruble can make it possible for the economy to better adapt to the fluctuations in the economic situation, and so promote the competitive capacity of domestic products and a well-balanced state budget.

At the same time, if the RF Bank had decided to keep the interest rate at the same level, this would have been read as a sign that the financial regulator –the RF Central Bank - perceived recession as a more serious threat than the ruble's depreciation, and therefore was ready to allow the inflation rate to surge, and the ruble to lose its value.

Faced by the necessity to make a choice between these two alternatives, the regulator resorted to a 'moderate toughening' scenario. In our opinion, the Bank of Russia's actions are on the whole correct. In this connection it should be borne in mind that the further movement of the ruble's exchange rate will be determined not so much by monetary policy, but by the movement of prices for energy carriers and changes in the geopolitical situation.

Pavel Trunin - Head of the Monetary Policy Department
Yevgeny Goriunov – Researcher