The CBR’s Board of Directors holds its regular meeting this Thursday.
The CBR’s meeting this Thursday is in the spotlight this week given the extreme volatility in local markets recently. As we feared, adjustment to lower oil prices was not particularly orderly and the CBR had to conduct outright FX interventions to stabilize the market – although only after allowing for a significant overshoot from what could be considered as equilibrium fair exchange rate. We estimate that the CBR sold more than USD 4bn last week to support the currency.
The sharpness of the adjustment (5-7% daily moves were not infrequent over the last couple of weeks), as well as the acute spike in volatility (north of 40%), also suggests that market expectations might have de-anchored from equilibrium considerations, demanding policy action from the CBR.
We believe that a proper policy reaction from the regulator could be three-pronged:
Increase in policy rate. The pressure to increase interest rates is evident from both financial stability and inflation considerations. As for the latter, headline CPI rose to 9.1% YoY in November (from 8.3% in October) and the pass-through from import embargo and rouble devaluation are set to push it to around 11% at its peak in 1Q15. The likely upward revision in the short-term CPI forecasts by the staff could therefore be a formal trigger for a rate hike. As for the magnitude of any increase, we believe that the CBR might want to be bold and increase rates by up to 100‑150bp.
Improve dollar liquidity provision facilities. For many reasons, the uptake of dollar liquidity from the recent dollar repo and dollar swap auctions was subdued, suggesting that the CBR needs to be more proactive in improving these facilities – especially in light of rising signs that issues related to a shortage of dollar liquidity are starting to resurface (basis has once again dipped well inside the negative area). We believe there are many ways to address the dollar liquidity shortage in the banking system, starting from more active interventions in the FX swap market (targeting FX swap not far from RUONIA) to a forced dollar liquidity injection (in the form of deposits, for instance).
Ad-hoc outright FX interventions. In the interim, before the above measures bring about results, the CBR might continue to use ad hoc interventions to tame the volatility on the FX market.
The communication from the regulator has been mixed lately, which makes it difficult to predict what could be the policy action this week. An alternative the CBR might well choose is to follow through on threats to squeeze rouble liquidity. We fear that engineering a rate spike risks de-anchoring interest rate expectations and putting financial stability in danger. Moreover, this policy path falls short of addressing the main concerns related to de-anchored expectations and the dollar liquidity shortage and, hence, is unlikely to bring about long-lasting results.