The Bank of Russia increased its benchmark rate by 350 basis points to 12 percent on Tuesday following a recent plunge of the ruble in the forex market.
"Inflationary pressure is building up," the central bank said in a statement. "The decision is aimed at limiting price stability risks.
"The pass-through of the ruble's depreciation to prices is gaining momentum and inflation expectations are on the rise."
On Monday, the ruble plunged to its lowest point in over 16 months against the U.S. dollar, falling below the critical 100 level. It prompted central bank officials to conduct an extraordinary rate meeting. Following the central bank's decision, the ruble still traded 0.4 percent weaker on Tuesday morning but significantly above the previous lows.
President Vladimir Putin's economic advisor Maxim Oreshkin previously argued that the central bank's "soft monetary policy" had caused the ruble to weaken. According to Oreshkin, the ruble's exchange rate has "deviated significantly from fundamental levels." He stressed the need for a "strong ruble" for the interests of the Russian economy.
The central bank last made an emergency rate hike in February last year, raising the key rate to 20 percent immediately after the Ukraine War broke out. The Bank of Russia then steadily cut rates, bringing the key rate to 7.5 percent in the second half of 2022 as inflation pressure eased.
After making its last cut in September last year, the bank maintained the key rate at the 7.5 percent level until July. At its scheduled policy meeting last month, the bank hiked the rate by 100 basis points to 8.5 percent. The next policy decision is due in mid-September.
Sovcombank chief analyst Mikhail Vasilyev said the key rate had peaked in this tightening cycle, predicting that the Bank of Russia would maintain its current rate until the year's end. According to Vasilyev, the rate cut may happen next year when inflation slows.
Inflation pressures in Russia
After experiencing double-digit inflation last year, price growth slowed in Russia in the spring of 2023 because of the high base effect. However, in July, annual inflation rose to 4.3 percent, above the central bank's target rate of four percent.
Although the inflation rate is significantly lower than European peers, thanks to Russia's energy resources and early post-pandemic recovery, seasonally adjusted inflation last month stood at 8.5 percent. A recent forecast also shows that inflation will continue to increase, hitting 5.0 to 6.5 percent by the end of 2023.
Alexandra Prokopenko, a former Russian central bank official, said the ruble exchange rate was only one of many indicators of a "very badly balanced" economy. Analysts say fiscal spending and fluctuations in commodity prices will significantly influence the Russian economy in the coming months.
Impact of weakening ruble
Since the New Year, the ruble has fallen by 26 percent because of the decline in Russian export revenues and increasing monetary spending. The Russian currency has become the third worst-performing currency in the global market this year.
"The Russian rouble is still searching for its appropriate long-term war-sanctions exchange rate. Without capital controls, speculators would have priced in the poor outlook last year."
Janis Kluge, Researcher at German Institute for International and Security Affairs
German Institute for International and Security Affairs researcher Janis Kluge said the Russian ruble was still finding for its "appropriate long-term war-sanctions exchange rate." Without capital controls from Moscow, the currency would continue its downward trend.
In the short term, the weakening ruble can help Moscow fund its war spending with more ease. According to a recent report, Moscow had doubled its war budget to $100 billion this year, equivalent to a third of the public spending.
However, an anonymous Kremlin official said Monday that a weak ruble would negatively affect the population's real incomes. Households will face higher consumer prices, lowering their purchasing power.
Last week, the Russian central bank halted the purchase of foreign currencies in the domestic market to stabilize the ruble. However, analysts pointed out that it did little to prop up the Russian currency.