Central Bank of Russia’s rate hike a mistake, says Merrill Lynch

All summer, the Central Bank of Russia has focused strongly on inflation targeting by hiking rates, but Bank of America Merrill Lynch says it is misguided in its policy.

On September 13, the CBR hiked all of its key interest rates by 0.25% over inflation concerns. Year to date, inflation in Russia has risen to 6.3%, crossing the 6% target. A further increase to 6.5% is expected by the end of the month.

As inflation rises, there are concerns in the market that the Central Bank may initiate a further 0.25% hike in interest rates.

This monetary tightening goes against the general trend in all other BRIC countries – Brazil, China and India. They, on the contrary, have been cutting rates or keeping them low as inflation concerns rise.

Bank of America Merrill thinks CBR’s action is a “considerable policy mistake.”

Vladimir Osakovskiy, chief economist at Merrill Lynch in Moscow, says “further monetary tightening in 4Q12 will likely have adverse implications for economic growth, as it will help to undermine bank lending growth and already weak investment demand, and boost imports growth by supporting the ruble.”

As Russia’s capital flight year to end of August has already exceeded $52bn, it would be much more prudent to attract capital into the country by keeping exports affordable, instead of allowing more money to exit the country.

Merrill Lynch estimates that a further rate hike in October could drive GDP growth in the second half of the year down from 3.9% to 3.3%.

Instead of increasing rates, Merrill Lynch suggests the next step should be to cut them, but not until next year.

As growth in Russia weakens towards the end of the year, Osakovskiy says inflation will be kept under control. As a result, “the economic slowdown and largely limited inflationary risks should help to shift the CBR’s focus from inflation back to economic growth.”

The bank’s next move should be monetary easing as inflation starts to slow down. Osakovskiy expects this to happen towards the latter half of next year.

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