Central Bank Cuts Refinancing Rate 1/2 Point

The Central Bank announced Thursday that it would cut its key refinancing rate to 12.5 percent from 13 percent as the government grows more confident that it has brought inflation and the volatile ruble under control.

The bank also said it would raise banks' mandatory reserve requirements beginning May 1, a sign that the bank has chosen to continue its cautious monetary policy, market participants said.

The Central Bank will raise banks' mandatory reserve requirements by 0.5 percentage points on a monthly basis from May to August. This will decrease the money that the banking sector can freely lend, therefore counteracting the expansionary rate cut so that the monetary base stays relatively stable, said Yevgeny Nadorshin, chief economist at Trust Investment Bank.

"The Central Bank isn't going to push an aggressive expansionary policy -- that's why the rate cut is so small, and that's why they're increasing the mandatory reserves," Nadorshin said.

The rate cut, which takes effect Friday, comes a day after Prime Minister Vladimir Putin appeared to suggest at a government meeting that lowering inflation should bring an interest rate cut.

"According to Economic Development Ministry forecasts, April inflation will be 1.1 to 1.2 percent. That means we can expect a reduction of the Central Bank's refinancing rate. Isn't that so, Sergei Mikhailovich?" Putin said, addressing Central Bank Chairman Sergei Ignatyev.

"Of course, we understand that this issue is within the exclusive competence of the Central Bank's board," he added, without waiting for Ignatyev's response.

The Central Bank said Thursday that it would also cut the repo and Lombard rates to 11.5 percent. All reductions take effect Friday.

Two weeks ago, Ignatyev said the Central Bank would consider lowering the refinancing rate "as long as inflation decreases," just a week after Putin told a group of Novokuznetsk coal miners that cutting it below the inflation rate would "destroy" the banking system.

In November, the Central Bank began a series of interest rate hikes, pushing the refinancing rate to 13 percent from 11 percent in a few weeks. This followed a cut in the reserve requirement in the months before, which saw the figure fall from 8.5 percent to 0.5 percent.

The high interest rates have since faced pressure from bankers, who complain that the cost of lending is too high -- especially as the central banks of most developed economies have cut rates drastically. Among the most vocal critics has been Alfa Bank president Pyotr Aven, who predicted last month that high lending rates would push hundreds of banks into bankruptcy by the third quarter. The morning after Aven's comments, the Central Bank's deputy head Alexei Ulyukayev told Ekho Moskvy that a rate cut might be in the works, albeit a small one.

Nadorshin predicted that the Central Bank would cut the rate again in May by another 0.25 or 0.5 points and that it could lower the rate a total of four to six times this year. The bank will not let the rate fall below 11 percent, Nadorshin added, as inflation may reach 15 percent this year.

Thursday's rate cut should in turn allow banks to cut their lending rates, said Sergei Guriyev, a professor at the New Economic School. Banks will be anxious to keep their interest rates no more than three percentage points above the Central Bank rate -- a demand of Putin's -- as their current rates are hardly sustainable, Guriyev said.

For now, though, such a small rate cut will make "no material difference," said Chris Weafer, chief strategist at UralSib. "People will take the half-point rate cut as a step in the right direction, but we have such a long way to go," Weafer said.