UPDATE 2-Russia c.bank holds rates, watches mid-term inflation

Tue Mar 13, 2012 6:10am EDT

* C.bank decision matches market expectations

* C.bank says happy with current rate spread

* Says watches mid-term inflation trend

* Market shows muted reaction

* Cut in lending rates expected later this year

By Andrey Ostroukh

MOSCOW, March 13 (Reuters) - Russia's central bank left key interest rates unchanged on Tuesday and said the current spread between lending and deposit rates was appropriate, suggesting it is still concerned a record slowdown in inflation may be temporary.

A rate cut, however, is likely to be in the pipeline later this year as a more accommodative policy may be needed to boost lending, internal demand and economic growth as a whole.

The central bank left the refinancing rate, or the cost of overnight loans from the central bank, at 8 percent and the fixed one-day repo rate, the effective ceiling for interbank money market rates, at 6.25 percent.

The deposit rate, the key influence on borrowing costs at times of excessive liquidity, was also left unchanged at 4 percent.

The central bank said in an accompanying statement that real money market rates, which hover within the central bank's corridor, are reasonable and had justified the decision.

"The decision is made on the back of an assessment of inflationary risks and the economy's growth prospects, given the continued uncertainty over developments in the external economic environment," the bank said.

The decision was widely expected by the market after policymakers signalled a month earlier they were satisfied with current rates.

The rouble showed no immediate reaction, trading at 29.53 per dollar by 0905 GMT.

The stock market retained early gains, with the dollar-based RTS index up 0.9 percent and the MICEX rouble-traded index adding 0.4 percent on the day.

INFLATION VS GROWTH

Analysts expect the bank will ease monetary policy cautiously later this year to support the economy, with gross domestic product growth slowing to 3.9 percent in January from 4.3 percent in the whole of 2011.

The PMI index showed growth in Russian manufacturing continued to slow in February, while growth in activity across service industries slowed from a six-month high.

Inflation hit a new post-Soviet low of 3.7 percent year-on-year in February, remaining well below the central bank's full-year target of 5 to 6 percent. But inflationary risks are not fully contained.

"A planned delay in increase of most of tariffs until the middle of 2012 and the rouble's firming in recent months have contributed to an inflation slowdown," the central bank said, adding that it also watches medium-term inflation forecasts.

The central bank pointed out that consumer sector growth outpaced industrial output, and that retail lending growth remains strong. It also noted the high rate of growth in real wages and low unemployment - factors which could potentially add to inflationary pressures in the months ahead.

Analysts at Nordea bank said in a note that the bank was acting in a "very forward-looking" way, showing that the drop in inflation is a short-term development.

Inflation is expected to spike later in the year after the government proceeds with annual hikes in prices, including higher charges on housing and transport costs.

Prime Minister Vladimir Putin has also helped keep a lid on overall inflation by ordering a freezing of gasoline prices in the run up to the March 4 presidential election, in which he won a new six-year term.

"Another part of the deceleration was not without the 'invisible hand' of the Russian government," analysts at Nordea said, referring to Putin's pre-election measures.

While inflation risks have faded for time being, lending activity and the health of the economy are likely to be the central bank's priorities in setting monetary policy.

"We still think that in the future the central bank's focus will move towards risks of a slowdown in lending and domestic demand," said Maria Pomelnikova, an analyst at Raiffeisen bank in Moscow.

"In this case case it would be logical to expect a narrowing of the rate spread," she said, suggesting that lending rates will be cut by at least 25 basis points in the second quarter.

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