Russia Raises Rates as Threat of Sanctions Looms

Key to that decision is the country’s inflation rate, which rose to 8.7% in January from 8.4% in December despite the Bank of Russia’s seven rate rises last year. But the central bank is also aware of the risk of an inflation-boosting weakening of the ruble should the West impose sanctions in response to any aggression by Russia toward Ukraine.

“Short-term proinflationary risks associated with volatility in global financial markets caused by, among other factors, various geopolitical events, intensified, which may affect exchange rate and inflation expectations,” the central bank said in a statement.

According to officials in the Biden administration, potential sanctions could target several of Russia’s largest government-owned banks, such as VTB Bank, and include the banning of all trade in new issues of Russian sovereign debt and the application of export controls across key sectors such as advanced microelectronics.

Off the table, for now, are sanctions on oil and natural-gas exports or disconnecting Russia from Swift, the basic infrastructure that facilitates financial transactions between banks across the world, the U.S. officials said, but that could change depending on Russian actions.

The Bank of Russia has recent experience of the impact of Western sanctions on the ruble and the country’s financial markets.

After Russia invaded Ukraine in 2014, the Obama administration went after some energy-technology exports, sovereign debt and some government-owned banks and firms, and those sanctions contributed to a weakening of the ruble. In December of that year, with the currency in free fall, the Bank of Russia raised its key rate to 17% from 9.5% in two moves, the second of which was by far the larger.

A weaker currency would push inflation higher by raising the prices of imported goods and services, while also raising the ruble cost of repaying debts denominated in U.S. dollars or euros.

However, since that experience, Russia’s government has worked to reduce the country’s reliance on U.S. dollar financial flows and Western financial institutions.

There are few signs of a collapse in the currency as tensions between Russia and the West over its troop buildup on Ukraine’s border continue. The ruble lost ground against the U.S. dollar on foreign-exchange markets in the first weeks of the year, but has since steadied as diplomatic efforts to find a peaceful resolution continue. However, the central bank can’t rest easy, economists say.

“The risk of another FX shock still lurks in the background,” wrote Tatiana Orlova, an economist at Oxford Economics, in a note to clients. “Geopolitical tensions are still simmering, though the recent flurry of European diplomacy reduces the chance of a military conflict between Russia and Ukraine.”

With or without sanctions, the central bank said it might have to raise its key interest rate further, citing the impact of a tight jobs market on wages.

Write to Paul Hannon at [email protected]