This is the perfect storm for Russia: there are Western sanctions on its businesses, the oil price is falling and now the Federal Reserve has turned off the cheap liquidity tap.
The latter alone, after six years of money-printing, would be enough to force the central bank hike rates. With the flow of cheap money into emerging markets slowing, other central banks are tightening monetary policy.
The Russian currency, the ruble, has been in a race to the bottom with itself, hitting new low after new low versus the euro and the dollar.
Cheaper oil due to a glut of US shale production and a weaker global economy depressing demand means revenues from Russia’s main export are dwindling.
The cost of Russia’s own brand of attrition war with the West – with more than 10 military aircraft, of which six nuclear bombers, caught recently carrying out operations near NATO space – must be adding hefty bills to the government’s spending.
The central bank has the unenviable mission of having to balance all that with a decision on interest rates.
The ruble has fallen by more than 20% against the dollar this year – the largest fall of any emerging market currency except for Argentina, Capital Economics chief emerging markets analyst Neil Shearing points out.
The market consensus is for a 50 basis points hike in the Russian central bank’s main interest rate, to 8.5%.
But Shearing expects a 100 basis points hike, to 9%, as the central bank is “faced with a collapse in the currency.”
There are two kinds of interest rate hikes, in the opinion of Benoit Anne, head of emerging markets strategy at Societe Generale.
The first is a normal, inflation-targeting kind of interest rate, which is meant to only deal with price rises. The second has to take financial stability into account and it is larger than the first.
“The local curve implicitly prices in a rate hike of almost 100 basis points for Friday, thereby leaning towards a financial-stability rate hike,” Anne wrote in a market note.
The most hawkish analyst is Simon Quijano-Evans, Commerzbank’s emerging markets expert. He expects Russia’s central bank to hike its interest rate by at least 200 basis points.
He also believes the central bank must abandon its current policy, which sees the ruble float within a band that is adjusted automatically depending on the foreign exchange operations of the finance ministry.
The Russian central bank’s band policy and cumulative foreign exchange sales “are just draining FX reserves and helping the self-fulfilling ruble weakness,” Quijano-Evans wrote in a recent market note.
He also said that the ruble’s weakness had a “psychological effect” on the population, which is compounded by some increases in food prices caused by the various import bans that Russia imposed in a tit-for-tat for Western sanctions.
The ruble’s weakness is adding to the negativity foreign investors feel after the EU/US sanctions have affected their holdings.
To stop the currency’s freefall, in addition to a 200 basis points rates hike and an end to the band float, the Russian central bank should also do a one-off currency intervention worth between $5 billion and $10 billion, Quijano-Evans said.