UPDATE 2-Russia, worried by inflation, hikes deposit rates

* Raises deposit rates, leaves lending rates on hold

* Decision was expected by strong minority of analysts

* Says inflation risks deserve attention

* More moves seen in early 2011

(Adds analysts, market reaction)

By Toni Vorobyova and Yelena Fabrichnaya

MOSCOW, Dec 24 (BestGrowthStock) – Russia’s central bank raised
interest rates on its deposit operations on Friday to contain
surging inflation, its first step away from the loose policy
implemented after the financial crisis hammered the Russian
economy.

The bank lifted its deposit rates by 25 basis points but
left the cost of lending operations — including the benchmark
refinancing rate — unchanged, saying a narrower corridor
between the cost of various instruments would increase the
effectiveness of its interest rate policy.

Analysts said further tightening would likely follow in
early 2011, given the central bank’s increasing focus on price
pressures and relative optimism on the strength of the economy.

“Inflation risks, as determined by monetary conditions,
remain moderate but deserve greater attention from the
authorities,” the central bank said in a statement, adding that
economic recovery remains on track.

“The change … will not lead to a significant increase in
the cost of funds for end borrowers.”

The overnight deposit rate will be raised to 2.75 percent,
as of Monday, from 2.50 percent. The refinancing rate remains at
a record low of 7.75 percent. [ID:nLDE6BN0H4]

Most analysts had expected no change Friday, but eight of
out of the 19 analysts polled by Reuters earlier this week had
forecast a hike in the overnight deposit rate. Some had also
expected an increase in the refi rate. [ID:nLDE6BL0TZ]

“I think they will start to raise other rates from the end
of January. The increases will be gradual, at 25 basis points a
month, with a total potential of 75-100 bps by the end of the
first half,” said Maria Pomelnikova at Trust, who sees inflation
reaching 9 percent by mid-2011.

The bank last hiked rates in late 2008 in a bid to support
the rouble and deter capital flight, but subsequently cut them
again has the economy contracted sharply.

MARKETS UNSURPRISED

Markets were positioned for the move after the central bank
in November removed a reference to policy being on hold in
coming months, and officials said tightening was possible.

The rouble and money market showed little reaction to the
actual decision, having surged this month in anticipation.

“The market had started to price in a possible interest rate
hike well in advance,” said Viktor Kholoshnoy at Gazprombank.

Longer-term, if more rate hikes follow, the rouble (RUS=MCX: )
could continue to appreciate as it recovers its status of a
high-yielding currency, analysts said.

Weekly inflation has accelerated to 0.3 percent, bringing
the year-to-date figure to 8.4 percent and leaving real interest
rates deep in negative territory. [ID:nLDE6BL1B2]

Ahead of the decision, central bank governor Sergei Ignatyev
told lawmakers that he was “worried about inflation,” although
its spike was mostly caused by a rise in food prices after the
worst drought in over a century.

Policy makers are concerned that second-round effects, such
as rising meat prices, will push inflation higher towards the
middle of next year. That may lead the central bank to miss its
end-2011 inflation target of 6-7 percent.

FIRST STEP ON LONG PATH

By raising only deposit rates, which serve as the de facto
policy rate at a time of abundant liquidity, the central bank is
seeking to shift towards a policy framework where interest rates
will supplant the exchange rate as the primary focus.

The ultimate goal is to introduce a conventional inflation
targeting regime, but with policy rates deeply negative in real
terms that remains a considerable way off.

“The narrowing of the corridor … is aimed at increasing
the effectiveness of interest rate policy, the conditions for
which have in part been created by the increased flexibility in
the rouble exchange rate achieved this year,” the bank said.

With the corridor still some 500 basis points wide, the
central bank could continue to limit its tightening to the
deposit rates given that high liquidity means banks are less
interested in borrowing money from the central bank.

“Increasing the deposit rates will lead to tighter
conditions on the money market. Banks have nowhere to put their
money and the only risk-free investment is central bank
deposits,” said Maxim Oreshkin at Credit Agricole.

“This was the first step on the fairly long path of
tightening monetary policy.”

(Additional reporting by Andrey Ostroukh and Katya
Golubkova, Editing by Douglas Busvine, Ron Askew and Toby
Chopra)

UPDATE 2-Russia, worried by inflation, hikes deposit rates