Russia prepared for a massive interest rate increase as concerns mounted that it is losing the fight against inflation.

• The central bank of Russia is predicted to increase interest rates significantly this week due to the ongoing inflation in the economy affected by war.
• Despite repeated rate hikes by the central bank, Russia's consumer price index continues to rise.
• In November, the consumer price index increased to 8.9% from the previous year, and was higher than the 8.5% recorded in October.
• A weaker ruble — following new U.S. sanctions — has fueled inflationary pressures.

The central bank of Russia is predicted to increase interest rates significantly this week due to the ongoing inflation in the economy affected by war.

Despite the central bank's repeated rate hikes, Russia's consumer price index continues to increase, reaching 8.9% in November compared to 8.5% in October, mainly due to rising food prices.

The new U.S. sanctions in November have weakened the ruble, leading to inflation and higher import costs in Russia, which has been severely impacted by its invasion of Ukraine in 2022.

The CBR is predicted by economists to increase Russia's central bank interest rate by 200 basis points to 23% at its meeting on Dec. 20.

According to Liam Peach, senior Emerging Markets economist at Capital Economics, the recent increase in Russian inflation to 8.9% year-on-year in November and the likelihood of further increases in the coming months strongly suggest the need for another large interest rate hike from the central bank.

He stated that prices will continue to increase, and inflation is expected to exceed 9.0% annually by 2025.

Peach stated that with firms' price expectations also reaching new highs, there is a clear argument that the central bank is losing the battle against inflation and will be forced to hike rates sharply again. In our view, a 200 basis point rate hike is the base case, but there are arguments in favor of a larger hike.

Price rises

At its October meeting, the central bank raised interest rates by 200 basis points, citing that inflation was "significantly higher" than its summer projections and that inflation expectations were still on the rise.

The CBR stated that the growth in domestic demand is significantly exceeding the capabilities to increase the supply of goods and services.

The prices of basic foodstuffs, including butter, eggs, sunflower oil, and vegetables, have significantly increased in Russia, with demand exceeding supply.

The conflict between Russia and Ukraine has resulted in labor and supply shortages, leading to an increase in wages and production costs, which have been passed on to consumers. Despite this, the Russian government attributes the high cost of living to sanctions imposed by "unfriendly" countries. Meanwhile, Russian President Vladimir Putin has denied trading "butter for guns."

The International Monetary Fund predicts that Russia will experience a sharp slowdown in growth, with 3.6% expansion in 2024 followed by 1.3% growth in 2025. This is due to a decrease in private consumption and investment, as well as reduced labor market tightness and slower wage growth.

Weak ruble

Despite Russia's efforts to mitigate the effects of sanctions through import substitution and oil and gas exports to countries that accept them, international penalties are still having a negative impact.

In November, the Russian ruble dropped sharply against the dollar, reaching its lowest level since March 2022, at 114 to the greenback, following another round of U.S. sanctions targeting Russia's third-largest bank, Gazprombank. These measures aim to prevent the bank, which the U.S. Treasury claims acts as a conduit for Russia to purchase military materials and pay Russian soldiers, from engaging in any energy-related transactions involving the U.S. financial system.

The central bank intervened to stabilize the ruble after its sudden decline, stating that it would halt foreign currency purchases for the remainder of the year to minimize market volatility.

Last month, Putin stated that the situation is under control.

Putin assured reporters that there were no reasons for panic, as reported by RIA Novosti.

The ruble exchange rate fluctuations are linked to inflation, budget payments, and oil prices, as well as seasonal factors, according to the speaker.

Despite recent gains, the ruble is still down about 3% against the dollar over the past month. It was trading at 103 rubles to one dollar on Monday.

While the war continues, analysts Alexandra Prokopenko and Alexander Kolyandr argue that Russia's central bank has limited options to combat inflation and the ruble's depreciation.

The analysis for Carnegie Politika pointed out that the ruble's weakness is still a fundamental reason for its continued instability, and the dynamics of Russia's trade flows mean that the currency will likely continue to falter and inflation will rise.

Despite significant state spending, the Russian economy is slowing down, and the ruble exchange rate dynamics suggest that the country is heading towards stagflation, which is a dangerous combination of slow growth and rising prices.

"The war and Western sanctions, as well as the militarization of Russia's economy, are the root cause of the country's financial problems. Despite having the power to address this issue, Russia's financial authorities are hesitant to speak about it publicly."