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The Central Bank of Russia (CBR) surprised markets by raising its key rate by 25bp to 7.50% today, points out Egor Fedorov, Senior credit analyst at ING.

Key Quotes

 “The key reasons for the CBR’s rate hike today included higher inflation risks based on the high degree of external uncertainty and its impact on financial markets. According to the CBR, a further rise in yields in developed markets, capital outflows from emerging markets and geopolitical risks could contribute to continued high financial market volatility – so influencing Rouble and inflation expectations.”

“The necessity of further increases in the key rate will depend on inflation and economic growth performance compared to the CBR’s expectations and also to external risks and the reaction of financial markets.”

“At the same time the CBR published revised forecasts, with annual inflation to reach 5-5.5% by the end of 2019 (from 4-4.5% previously), FY18 GDP growth remaining at 1.5-2.0%, and FY19 growth cut to 1.2-1.7% (previously 1.5-2.0%).”

“The CBR now expects to see annual CPI at 3.8-4.2% (vs. 3.5-4.0% in previous forecasts) by the end of 2018 with inflation peaking in 1H19 and reaching 5.-5.5% by the end of 2019.”

“Close to the end of 2019 quarterly inflation is expected to reach 4.0%, with annual inflation to reach the 4.0% target in 2020 (in line with previous expectations).”

“In another move to support the RUB, the CBR also suspended FX buying under the Finance Ministry’s Fiscal Rule until year-end.”

Our view. The decision to hike rates was unexpected for us and for the market, where “no action” was the consensus. Together with the ban on FX purchases, this will add stability to the local FX market. USD/RUB dropped by 1.5% to 67.50 and OFZ yields pared 10-11bp gains ahead of the decision and are now flat to the close.”

Rouble outlook

Consistent with a better EM environment this week on the back of a Turkey rate hike and soft US CPI, today’s move could see some further modest gains in the RUB to the 67.00/67.30 area.

However, we doubt investors will want to chase the RUB too much firmer. More aggressive sanctions against Russia will be debated in the US Congress into and after US mid-term elections and, given a backdrop of rising US rates and unresolved trade issues, we maintain a view that USD/RUB will be trading back above 70 over coming weeks and months.”

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