Russia's central bank raised its key policy rate by another 50 basis points to 7.5 percent due to rising inflation and said it did not intend to lower the rate in coming months to ensure that inflation remains below 6.0 percent by the end of the year.
The Bank of Russia, which raised its rate by 150 basis points on March 3 in response to volatility in financial markets from investors' nervousness over the conflict with Ukraine, said the probability of inflation exceeding the bank's 5.0 percent target for 2014 had increased substantially, mainly due to the larger-than-expected impact of a depreciation of the ruble on consumer prices.
The central bank also said Russia's economy will continue on a downtrend this year with limited boost to activity from the ruble's depreciation.
Earlier this month, the central bank said the economy would probably expand by less than 1.0 percent this year and the finance minister said growth may be around zero, days after the Economy Ministry lowered its growth forecast to 0.5 percent from a previous 2.5 percent due to lower demand for exports, slowing consumer activity, capital outflows and a decline in investment.
"Amid economic uncertainty and declining producer confidence there is a strong probability of a reduction in fixed capital investment," the central bank said, its only direct reference to the impact on the Russian economy from the conflict with Ukraine and western sanctions.
Russia's headline inflation rate rose to 6.9 percent in March from 6.2 percent in February and accelerated further to 7.2 percent as of April 21, with weekly inflation at 0.2 percent, the bank said. Core inflation also accelerated to 6.0 percent in March from 5.6 percent the previous month.
It attributed the rise in inflation to the pass-through effect of the ruble's depreciation, a rise in inflationary expectations and "unfavorable" market conditions for diary products, sugar, pork and petrol.
"Since monetary policy affects the economy with a lag, the probability of inflation exceeding the 5.0% target at end-2014 has increased substantially," the bank said, adding that the rate rise would help ensure that inflation declines to no more than 6.0 percent by the end of 2014.
The central bank expects inflation to remain around the current level until the middle of this year, with consumer prices decelerating in the second half due to lower planned rises in administered prices, falling inflation expectations and the economic activity that is below potential.
"The current economic slowdown is predominantly structural by nature and thus does not exert any noticeable downward pressure on inflation," the bank said.
The central bank painted a dim outlook for the economy.
Growth in labour productivity is "sluggish," fixed capital investment is contracting due to falling profits, there is limited access to long-term financing in both international and domestic markets, and producer and economic confidence is low, and economic activity in most of Russia's trading partners is weak, further restraining economic growth.
Russia's Gross Domestic Product contracted by 0.5 percent in the first quarter of the year from the fourth quarter for annual growth of 0.8 percent.
Russia's ruble started weakening against the U.S. dollar in February last year with the fall accelerating in January, along with many other emerging market currencies.
An escalation in tensions between Russia and Ukraine sparked a further decline in the exchange rate in March with the central raising the threshold for adjusting the ruble's trading corridor only after it spends up to $1.5 billion to keep it within the band, a threshold that was raised from a previous $350 million.
Unnerved by concerns over further sanctions from the West and the escalating crises with Ukraine, the outflow of capital from Russia reached $50.6 billion in the first quarter of this year.
The ruble was trading at 36 to the U.S. dollar today, higher than a low of 36.92 reached right before the central bank raised its rate in March, but down 8.6 percent since the start of the year.
Along with its key rate, the Bank of Russia also raised its other main rates by 50 basis points. The one-day repo rate that provides liquidity to banks was raised to 8.50 percent from 8.0 percent, the one-day deposit rate was raised to 6.50 percent from 6.0 percent and the rate on open market, three-month operations was raised to 7.75 percent. The refinancing rate, which used to be the benchmark rate and is being phased out, was maintained at 8.25 percent.