The Bank of Russia, which hiked its benchmark rate by 150 basis points on March 3 after markets tumbled on fears of an outbreak of war between Ukraine and Russia, said inflation accelerated to 6.4 percent by March 11, up from 6.2 percent in February, partly due to the depreciation of the ruble along with higher prices for vegetables, fruit and dairy products.
This could boost inflationary expectations and the central bank said its priority was to "contain the effect of exchange rate dynamics on inflation and to maintain financial stability."
The central bank, which only last month expected inflation to gradually decline towards its target of 5 percent by the end of the year, said inflation rates are now unlikely to fall until the middle of this year due to the impact of the lower ruble and then decelerate to the target in the "medium term."
Russia's ruble has been weakening since early February last year and in 2013 it fell by over 7 percent against the U.S. dollar. On March 3 it tumbled 2.5 percent, triggering intervention worth $11.3 billion by the Bank of Russia followed by a further $300 million the day after to support the ruble. This helped control the fall but it has continued to depreciate, trading at 36.66 to the dollar today, down 10 percent since the beginning of the year.
"High inflation risks that brought about an increase in the key rate on 3 March 2014 still remain," the bank said. "Unstable external conditions and a rise in financial market volatility are conducive to an increase in economic uncertainty."
"Hence, the Bank of Russia does not intend to lower the key rate in the coming months," it added.
Investors remain on edge in light of Sunday's referendum in Crimea on whether it should join Russia and leave Ukraine. If Crimea votes to join Russia, as expected, Western countries may impose economic sanctions, further undermining investors' confidence in Russian assets.
Russia's economy was already slowing before the geopolitical tensions and the central bank said investment and consumption is likely to slow further due to the increased uncertainty and declining confidence, with the result that growth will be lower than expected.
In its policy report from February the central bank forecast growth this year of 1.5-1.8 percent, down from 1.3 percent estimated for 2013.
Demand from consumers has been the only real driver of economic growth in recent months as industrial production has been stagnating and investment low. But consumers have started to pull back due to slow growth in wages and deteriorating sentiment, the bank said.
In the third quarter of last year, Russia's Gross Domestic Product expanded by only 0.2 percent from the second quarter for annual growth of 1.2 percent.
The impact on growth from the depreciation of the ruble is seen as limited by the central bank.