UPDATE 2-Russian central bank warns of low growth, high inflation

Wed Apr 2, 2014 7:10am EDT

(Adds details on central bank intervention)

By Oksana Kobzeva and Jason Bush

MOSCOW, April 2 (Reuters) - Russia's central bank said on Wednesday economic growth would "most probably" fall below 1 percent in 2014 and it was also concerned about above-target inflation that constrains its ability to cut interest rates.

Despite the economic slowdown, central bank governor Elvira Nabiullina said the bank did not plan to cut its key lending rate from 7 percent until its June meeting at the earliest.

The combination of stagnating growth and high inflation underscores the debilitating impact that international tensions around Ukraine are having on Russia's poor economic health.

It also highlights the dilemmas the central bank faces as it struggles to reassure markets by stabilising the rouble - contradicting its long-term policy goal of letting the exchange rate find its own level.

Nabiullina told a Moscow banking conference that the bank's previous 2014 growth forecast in the range of 1.5-1.8 percent was now unlikely to be met.

"More probable is a reduction in the growth rate to a level below 1 percent," she said.

The bank is just the latest organisation to slash its growth forecast, as the deterioration of East-West relations provoked by the Ukraine crisis exacerbates a slump in investment and an outflow of capital.

Economists polled by Reuters last week cut their average 2014 growth forecast to 0.8 percent from 1.9 percent.

The central bank raised its key lending rate to 7 percent from 5.5 percent a month ago to protect the rouble when markets took a pounding on the first day of trading after President Vladimir Putin declared Russia's right to invade Ukraine.

Nabiullina said the rate would remain in place at least until June: "A signal was given at the March 14 board of directors' meeting that (the rate) will not be reduced during the coming months - at the very least until the June meeting."

The bank's next meetings to discuss monetary policy are scheduled for April 25 and June 16.

Nabiullina said rate cuts were not on the immediate agenda because of the bank's "serious concern" over high inflation, which she said was currently running at an annual rate of 6.64 percent.

"We expect to succeed in stabilising inflation in the second half of the year, but all the same the risks that it will remain above the target rate of 5 percent this year are high," she said.

Nabiullina said the bank will be acting to stabilise the currency in the short-term, putting off plans for gradually allowing the rouble to float more freely, as part of a strategy to move to a full rouble float in 2015.

"In connection with the high uncertainty, at the moment we are preserving the parameters of the exchange rate policy mechanism at levels needed to prevent excessive fluctuations of the currency," she said. "But after the stabilisation of the situation we will continue the gradual transition to a floating exchange rate."

CHANGED PARAMETERS

The central bank has committed to adjust the rouble's trading corridor only after it spends up to $1.5 billion to keep it within the band, a threshold it raised from $350 million a month ago as the Ukraine crisis unfolded.

Raising the threshold had the effect of making the corridor more rigid, increasing the overall amount the bank spends to limit changes in the currency's value.

Since Putin's March 1 request for parliamentary authority to use military force in Ukraine to protect Russian speakers, the bank spent $25.4 billion of its reserves, up from $7.1 billion in Feburary.

Although reassuring for jittery markets, such measures fly in the face of the bank's long-term strategy of letting the rouble float more freely - a goal widely praised by economists and investors as improving the monetary policy framework.

The central bank has reiterated its intention to shift to an inflation targeting regime from next year, which would mean eliminating the rouble's trading corridor and the routine central bank interventions that keep the rouble within it.

Despite the bank's reassurances, some economists doubt that this time-table is now realistic, given the risk of a further rouble slump that would exacerbate inflation.

"While the (central bank) tells the market that the early March decision to tighten the FX management regime is temporary, we believe the regulator is actually facing a dilemma between returning to free-float in 2015 or keeping the managed float regime," Alfa Bank analysts said in a report. (Reporting by Oksana Kobzeva; Writing by Jason Bush; Editing by Elizabeth Piper and Peter Graff)