Photograph by Andrey Rudakov — Bloomberg via Getty Images
By Geoffrey Smith
October 31, 2014

Russia’s central bank went into emergency mode Friday, raising its key interest rate by 1.5 percentage pointsto 9.5% in an effort to stop an alarming slide in the ruble and tame rising inflation.

The ruble has fallen by 26% against the dollar since the start of July, hitting one record low after another, as a combination of weak oil prices and worsening relations with the E.U. and U.S. have drained confidence from the economy.

The sense of gloom has deepened in recent weeks after Presidents Barack Obama and Vladimir Putin have traded barbs: Obama called Russia one of the biggest threats to global security after Islamic State and Ebola, while Putin last week accused the U.S. of leading the world into chaos by seeking to impose its power everywhere.

Although the ruble’s slide hasn’t yet eaten into Putin’s sky-high approval ratings, a poll by the Levada research firm earlier this week showed that 45% of people were concerned about the ruble’s decline–particularly in Moscow and among the better-educated and better-paid segments of society. That demographic featured prominently in the sometimes violent protests against Putin after his re-election in 2012.

News of the CBR’s plan to put a floor under the ruble had appeared to leak out Thursday, as the currency rocketed by nearly 6%. But the ruble gave back most of its gains against the dollar after the announcement, and by the close in Moscow was back at 42.88, less than 2% away from Wednesday’s all-time low.

Higher interest rates generally support a currency in foreign exchange markets, but at the cost of raising the cost of credit at home. Neil Shearing, chief emerging markets economist at Capital Economics in London, said the rate hike risks driving the economy into recession (the Central Bank predicted that growth would slow to 0% by the first quarter of next year).

The ruble’s decline has driven the cost of imports sharply higher, a trend made worse by Russia’s own decision to ban most European and U.S. food imports in response to sanctions on it. The annual rate of inflation has now risen to 8.2%, more than twice the bank’s medium-target of 4%. Food prices were up 11.4% on the year in September.

But it’s unclear whether the action taken will be enough to stop people betting on further declines. The Central Bank didn’t change its policy of keeping the ruble within a target band against a basket of dollars and euros. Currently, when the ruble hits the lower bound of that range, the central bank will spend up to $350 million in foreign reserves to support it before moving the band downwards.

That policy has led to a slow burn of $70 billion in foreign reserves this year, and Shearing argues that as long as that support is in place, people will bet on the ruble falling when it’s removed. The central bank had planned to move to a fully floating currency regime in January.

There’s still a whopping $440 billion left in the central bank’s kitty, and with oil prices appearing to bottom out around $80 a barrel, the ruble probably won’t continue to fall as fast, Shearing says (he expects it to be at 45 to the dollar in six months’ time). All the same, he argues, “history suggests you can get through your reserves very quickly when faced with a crisis like this.”

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