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Central Bank Says Rate Cuts No Longer Needed

The economy no longer needs the stimulus of rate cuts, and rates may remain on hold for the next few months, while any rise in inflation could prompt hikes in reserve requirements, Central Bank First Deputy Chairman Alexei Ulyukayev said Friday.

"On the one hand, inflation is still … easing compared with last year. On the other hand, there is a recovery in the economy, which is becoming more sturdy — this relates both to lending and to industrial output," Ulyukayev said in an interview.

"So the situation is no longer such that we must give extra stimulus to the economy by cutting rates. … The period of rates being kept at current levels will possibly last for the next few months. What happens after that, I cannot say."

The Central Bank has cut its benchmark refinancing rate by 525 basis points since April 2009 to a record low of 7.75 percent in a bid to help the economy recover from its worst recession in 15 years. But in May the Central Bank signaled a pause in the easing cycle and analysts now see rates on hold to year-end.

The next meeting on rates is due Wednesday.

While the refi marks the top end of the rates for Central Bank operations, the bottom is marked by the overnight deposit rate, currently at 2.5 percent.

"In theory … we would like the corridor between lending and deposit rates to be lower," Ulyukayev said.

"But in the current situation, the reduction of this corridor would mean that deposit rates should be fairly high, which would not be very good … [since it would encourage] the inflow of short-term capital, the carry trade."

Russia's high interest rates have attracted so-called carry trade investors who borrow in lower-yielding currencies to invest in high-yielding ones.

In quotes approved for publication earlier, Ulyukayev also explained in detail the Central Bank's foreign-exchange intervention mechanism.

The period of stable ruble appreciation is over and the ruble is now set for a volatile time without a clear trend in either direction, Ulyukayev said, reiterating previous comments and forecasting zero net capital inflows for the year.

He added that this should help keep inflation in check, forecasting that prices will rise by less than 0.6 percent in June and no more than 6 percent for 2010 as a whole.

Nonetheless, there is still potential for a rise in inflationary pressures in the final quarter "linked to the rise in money supply, the monetary base, the pickup in lending, the recovery in the economy," Ulyukayev said, adding that GDP could grow by more than 5 percent this year.

"If … the cycle of rate cuts is over or has paused, in that situation, if we see that there are inflation risks, we could use the mechanism of reserve requirements," he said.

Russia could also differentiate reserve requirements, making them higher for foreign currency obligations.

"The differentiation of the requirement is quite possible, but we must look at banks' balances, their foreign currency position, the dynamics of net foreign currency assets. For now there is nothing threatening happening here," he said.

"But if the situation changes, we will consider the issue."

Ulyukayev also reiterated Russia's commitment to move away from an exchange rate focus to target inflation while still retaining the right to intervene in the currency market.

Russia, the holder of the world's third-largest gold and forex reserves, has reiterated its faith in the euro in the wake of the fiscal troubles in the euro zone — a stance Ulyukayev repeated.

"We are not changing the share of the euro, we are not changing the official structure of the reserves," he said.

"The euro is a reserve currency, and I think this status will remain in the future. … I think there is a good chance that everything ends well. So I do not see a catastrophe, or big concerns with the euro."

The foreign currency part of Russia's $450 billion reserves remains unchanged at 47 percent U.S. dollars, 41 percent euros, 10 percent sterling and 2 percent yen. Despite pledging to add the Canadian dollar, Ulyukayev said the Central Bank had yet to do so because of technical reasons. The Australian dollar has also previously been mentioned as a possible investment candidate.

"With the Australian dollar, it's just an idea. While with the Canadian dollar it is already a project, we are working on it, with the Australian one it is just thoughts," he said.

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