Still Expecting A Rate Cut In Q115

Russian rate markets remain overly hawkish towards the Central Bank of Russia (CBR)'s monetary policy trajectory, in our view, following the surprise rate hike on July 25. According to the statement that accompanied the CBR's decision, the 50 basis points rate hike - which took the CBR's benchmark rate to 8.00% - was implemented in response to "the aggravation of geopolitical tension and its potential impact on the rouble exchange rate dynamics".

The CBR's decision appears to be prescient, given that a few days later the EU imposed sanctions on Russia for its alleged support for separatists in Eastern Ukraine, limiting Russian state-owned banks' access to European capital markets. We see limited risk of a rouble sell-off in the coming months, since even if further sanctions were to follow suit, they would likely fall short of limiting Russia's trade flows, and as such would unlikely trigger a major currency reaction.

At the same time, we maintain our core view that Kiev has little alternative but to cave in to Russia's demands for granting autonomy to Eastern Ukrainian provinces in the coming months. The Kiev government has only a few more months of gas reserves to withstand the disruption of gas supplies from Russia, and barring a sizeable financial help from the West, which looks unlikely following the government's recent collapse, we expect Kiev to ultimately accommodate Russian demands for federalisation in exchange for resumption in gas flows and discount gas prices.

Market Still Too Hawkish
Russia - 1-Yr Interest Rate Swaps And 3-Month Interbank Rate (MOSPRIME), %

Still Expecting A Rate Cut In Q115

Russian rate markets remain overly hawkish towards the Central Bank of Russia (CBR)'s monetary policy trajectory, in our view, following the surprise rate hike on July 25. According to the statement that accompanied the CBR's decision, the 50 basis points rate hike - which took the CBR's benchmark rate to 8.00% - was implemented in response to "the aggravation of geopolitical tension and its potential impact on the rouble exchange rate dynamics".

Market Still Too Hawkish
Russia - 1-Yr Interest Rate Swaps And 3-Month Interbank Rate (MOSPRIME), %

The CBR's decision appears to be prescient, given that a few days later the EU imposed sanctions on Russia for its alleged support for separatists in Eastern Ukraine, limiting Russian state-owned banks' access to European capital markets. We see limited risk of a rouble sell-off in the coming months, since even if further sanctions were to follow suit, they would likely fall short of limiting Russia's trade flows, and as such would unlikely trigger a major currency reaction.

At the same time, we maintain our core view that Kiev has little alternative but to cave in to Russia's demands for granting autonomy to Eastern Ukrainian provinces in the coming months. The Kiev government has only a few more months of gas reserves to withstand the disruption of gas supplies from Russia, and barring a sizeable financial help from the West, which looks unlikely following the government's recent collapse, we expect Kiev to ultimately accommodate Russian demands for federalisation in exchange for resumption in gas flows and discount gas prices.

As such, the next few quarters we believe receding geopolitical risks should provide some support for the rouble. This will reduce imported inflation, eliminating the need for the CBR to hike rates further. Supply-side inflationary pressures should also abate, as the forthcoming harvest season is widely expected to be good. Meanwhile, slowing economic growth and tighter credit markets will weaken demand-side inflation in the coming months. Against this background, we expect inflation to fall by Q115, allowing the CBR to begin unwinding its three emergency rate hikes implemented in H114 no later than Q115. In light of the latest rate hike, we have adjusted our forecast for the monetary policy rate to drop to 7.75% in Q115, against our previous forecast of 7.25%.

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