The underlying reasons for the decision by the Bank of Russia to stop buying foreign currency, including the U.S. dollar (USD), are more important than the decision itself.
The Russian central bank made the announcement as the ruble (RUB) fell to its lowest levels against both the USD and the euro (EUR) since March. The psychologically important levels of 60 for the USD/RUB and 67 for the EUR/RUB were breached, which quite possibly influenced the timing of the announcement in a bid to gain support for the ruble.
The statement from the Bank of Russia press service said the suspension of the replenishment of international reserves (foreign currency buying) was “associated with an increase in volatility in the domestic market.”
The effects of the monetary policy announcement were felt by mid-afternoon, with the ruble trading at 59.5 and strengthening to 58.48 in later trading.
Ivan Tchakarov, chief economist with Citi in Moscow commented, “[this decision] indicates that the central bank is looking to strike the right balance [between] the desire to continue cutting rates and the need to keep inflation under control.” Tchakarov added, “The central bank has some concerns that the weaker currency may jeopardize its inflation objective. With this decision in place, the central bank feels much more comfortable cutting [rates] on Friday.”
Meanwhile, 25 of 34 forecasts reviewed indicate that the central bank will cut its key rate by 0.5 points to 11 percent at its meeting due to be held on 31 July, according to Bloomberg. Rates have already decreased by 5.5 percentage points during the first half of this year.
The Bank of Russia allowed the ruble to float late in 2014 and since that time, it has had to intervene in the currency market on a daily basis with amounts of up to $200 million, in attempts to return its gold and foreign reserves to around $500 billion over the next three years. The reserves totaled $358.20 billion on the 17th of July.
Analysts at Sberbank CIB said the decision to halt foreign currency purchases, “risks confusing the market as to whether the central bank has indicated USD/RUB 60.0 as the upper band of its comfort zone.” The central bank came in for criticism last year when the ruble slipped badly to briefly hit a low of 80 to the dollar which resulted in emergency measures, such as a rates hike up to 17%, to keep the currency under control.
The weak spot in the Russian economy is the rate of inflation which has remained above the 15% level for a number of months, which is far above the target level of 4%.
The political impasse which resulted in Western sanctions against Russia has pushed the economy into a recession for the first time since 2009. Government data in May showed that the economy had contracted by 4.8% year-on-year while the June figure showed a smaller decline of 4.2%, which could mean that the economic decline is starting to bottom.