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10.06.2008 - MDM Comment: CBR acts on rates and RUB


Russia's Central Bank yesterday increased its key deposit and refinancing rates by 25bp, its third hike this year. Following hot on the heels of this action, the regulator today expanded its bid/offer corridor for the bi-currency basket by lowering the bid 7-8 kopeyks from 29.60 to 29.52-29.53, which translates into a nominal appreciation of the RUB of less than 0.3%.
Both actions were pre-announced by CBR officials in their most recent public statements (although the timing was uncertain), hence the market wasn't taken by surprise. Reaction in the local bond market was moderate, with insignificant price declines (yesterday) in some longer-dated papers.
The key question now is what the regulator will do going forward. On the one hand, inflationary pressures are high (trailing 12-month CPI around 15%), real interest rates remain in negative territory, and the regulator is acting with increasing speed (the pause between this and last rate hikes was only 1 month, with a 4 month pause prior to that), all of which implies that further rate hikes are likely. On the other hand, high RUB interest rates, coupled with a bullish view on the RUB, may boost ‘carry trade’ positions, fuel capital inflows, and in this way nullify anti-inflationary efforts (CBR overnight deposit rate now 3.5%, 1-week rate 4.0% vs. LIBOR at 2.69% and EURIBOR at 4.96%).
Nevertheless, we believe that there will in fact be room for the Central Bank to further tighten its monetary policy. Assuming inflation remains high, it is our view that the regulator will likely raise key rates by an aggregate of 50-75bp before the end of the year, a move that will be combined, we believe, with new actions on banks' obligatory reserve rates. In our view, the latter is an excellent tool to increase the cost of ‘carry trades’ (by increasing the reserve rates on liabilities due to foreign banks). Other considerations that make us believe the ‘carry trade’ risk is not significant at the current stage of the tightening cycle are: 
- the regulator's increased flexibility in managing RUB rate expectations, with the bid/offer corridor for bi-currency basket being expanded and interventions made anywhere within that range
- the upside risks for USD and EUR rates, as inflation risks are becoming a global phenomenon
- the low (if any) inflationary effect of more money being deposited at the Central Bank; other fixed income RUB assets (e.g. bonds, loans) still look quite expensive for foreigners vs. Eurobonds on a spread-over-swap basis
With regard to the nominal appreciation of the RUB, we believe that any material moves (greater than 0.5%) on this front are quite unlikely. At the same time, the volatility of the RUB is likely to increase as the CBR can now intervene at any level within its ‘corridor’.
Finally, for investors in RUB bonds, we continue to recommend sticking to the very short end of the curve, with the best opportunities being in the increasingly crowded primary market, as well as in bonds with put options coming and new coupons being set.

10.06.2008 13:52
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