Armenia's central bank raised its benchmark interest rate for the second time in a row, pointing to a rise in inflation expectations due to supply-side developments despite the general level of weak demand.
However, the board of Central Bank of Armenia (CBA) also said the risks of inflation deviating from its target were now balanced and to be consistent it would respond with the appropriate action to any fall in inflation expectations to ensure inflation meets its target of 4.0 percent.
CBA raised its refinancing rate by another 25 basis point to 5.50 percent and has now raised it by 125 points following a 100 point hike in December.
The latest rate hike unwinds the four rate cuts last year in response to the COVID-19 crises, with the refinancing rate now back to its level 12 months ago.
Last year's rate cuts in response to the pandemic had extended a monetary easing cycle begun in August 2015 during which CBA cut its rates 18 times and by a total of 6.25 percentage points until the last rate cut in September 2020.
The latest rate hike, decided by the bank's board at a meeting on Feb. 2, comes after the bank in December estimated it would need to continue to scale back its easy monetary policy stance to stabilize inflation around its target as prices were expected to accelerate due to rising global food prices and domestic demand.
CBA raised its refinancing rate by another 25 basis point to 5.50 percent and has now raised it by 125 points following a 100 point hike in December.
The latest rate hike unwinds the four rate cuts last year in response to the COVID-19 crises, with the refinancing rate now back to its level 12 months ago.
Last year's rate cuts in response to the pandemic had extended a monetary easing cycle begun in August 2015 during which CBA cut its rates 18 times and by a total of 6.25 percentage points until the last rate cut in September 2020.
The latest rate hike, decided by the bank's board at a meeting on Feb. 2, comes after the bank in December estimated it would need to continue to scale back its easy monetary policy stance to stabilize inflation around its target as prices were expected to accelerate due to rising global food prices and domestic demand.
Although the central bank raised its rate in response to rising inflation expectations, it said it would also take appropriate action to neutralize any risk of a deflation of inflation expectations to ensure inflation is around its target of 4.0 percent.
"The board of the central bank considers the risks of inflation deviating from its projected medium-term trend amid high uncertainties in the economic outlook are balanced, and is ready to respond accordingly in case of their emergence," CBA said.
Armenia's inflation rate accelerated to 4.5 percent in January from 3.7 percent in December, saying inflationary tendencies were emerging in international food markets and this was reflected in a rising inflationary environment in some of its partner countries.
"In such a situation, the CB board estimated that the inflationary impact on the Armenia economy from the external sector will continue," the bank said.
The rise in inflation comes against a backdrop of lower-than-expected economic activity in the fourth quarter due to martial law that was imposed during the armed conflict with neighboring Azerbaijan over the Nagorno-Karabakh region, and the spread of the coronavirus epidemic.
CBA expects slower lending in the economy to have a negative impact on domestic demand though at the same time there has been an improvement in international financial markets' view of the country's risk premium, and it called for policy makers to carry out structural reforms to improve the potential growth rate of the country along with appropriate fiscal policy.
On Dec. 30 CBA estimated Armenia's budget deficit would rise 4.8 percentage points to 6.2 percent of gross domestic product due to lower revenue from tax cuts that were approved in April last year to counter the threat to economic activity from measures to contain COVID-19.
Government debt was estimated to reach 61.5 percent of GDP and CBA said fiscal policy would be somewhat restrictive to help lower debt in the medium term.
In the third quarter of last year Armenia's GDP shrank by an annual 9.1 percent, up from a 13.7 percent decline in the second quarter.
In addition to the shock to its economy from measures to contain COVID-19, Armenia also saw its worst military confrontation with Azerbaijan over the Nagorno-Karabakh region since the early 1990s in October last year.
But after more than a month of bloodshed, Armenia and Azerbaijan signed a Russian-brokered peace deal on Nov. 10
Armenia's dram currency fell almost 8 percent on Dec. 23 to around 522 to the U.S. dollar but has stabilized around 525 to the U.S. dollar this year. Since the start of 2020 it is down 8.2 percent.
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