July 28, 2017 / 1:05 PM / 2 years ago

Russia holds rates amid geopolitical risks, sees cuts by year-end

MOSCOW (Reuters) - The Russian central bank held its key interest rate unchanged at 9 percent on Friday, citing geopolitical risks and inflationary pressures, but it indicated rate cuts would follow in the coming months.

Facing new U.S. sanctions and a recent spike in food prices, the central bank opted for a cautious no-change decision, even though inflation, its key area of focus, has nearly slowed to its 4 percent target.

The inflation slowdown has allowed the central bank to cut benchmark borrowing costs three times this year, helping the economy recover following two years of contraction.

“Volatility in global commodity and financial markets, as well as exchange rate dynamics amid elevated geopolitical risks may have negative implications for exchange rate and inflation expectations,” the central bank said in a statement.

The U.S. Senate this week voted almost unanimously to slap new sanctions on Russia and backed a provision that allows Congress to stop any effort by President Donald Trump to ease existing sanctions.

Although analysts have played down the potential economic impact of the new sanctions, the rouble has been dragged lower in recent days because of them. If rouble weakness were to intensify, that would represent an inflation risk.

Although annual inflation unexpectedly rose from 4.1 percent in May to 4.4 percent last month because of higher food prices, the central bank said it still saw room to cut the key rate in the second half of 2017 as a new harvest would help lower prices for fruit and vegetables.

“While making its decision hereinafter, the Bank of Russia will assess inflation risks, the inflation dynamics and economic developments against the forecast,” the bank said.

Keeping its 2017 economic growth forecast unchanged at 1.3-1.8 percent, the central bank noted that a decline in inflation expectations had come to an end.

“In order to maintain inflation close to the 4 percent target, the Bank of Russia will continue to conduct moderately tight monetary policy,” said the bank, which has previously promised to keep its key rate up to 3 percentage points above inflation.

“All in all, extreme caution is the focus at the CBR,” Dmitry Polevoy, chief economist at ING Bank in Moscow, said in a research note.

With the threat of more U.S. sanctions looming, the central bank likely wants to take no risks with financial stability by keeping rates stable, said Tim Ash, senior strategist at BlueBay Asset Management.

The bank is seen cutting its main lending rate to 8.25 percent by the end of the year, a Reuters poll showed last month.

Capital Economics said it expected the central bank to cut rates as soon as its next board meeting, scheduled for Sept. 15, as inflation would fall back towards the central bank’s target by year-end.

Editing by Catherine Evans

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