Russian central bank raises key interest rates to combat inflation fuelled by military spending

MOSCOW — Russia's central bank has raised interest rates to the highest since the Kremlin sent troops to Ukraine more than two and a half years ago, in a move aimed at combating inflation fueled by huge government spending on the military and high levels of shopping by Russian consumers.

The bank raised its key interest rate to 19%, just below the level seen at the end of February 2022. Then the key rate reached an unprecedented 20%, in a desperate attempt by the bank to support the ruble and avert a financial collapse in the face of sanctions imposed by Western governments.

The situation today is different: inflation is a sign of overheating of the economy because government spending and consumer demand are greater than the economy's capacity to produce goods and services.

Muscovites shopping on Bolshaya Dorogomilovskaya Street in western Moscow on Thursday were well aware of the pace of price increases.

“I wish wages would rise as much as shop prices,” says Natalya, who, like others, does not want to give her last name. “Everything is expensive. Eggs, bread, flour, sugar, salt, everything is expensive.”

Andrej said that “half of the salary goes on food alone. And considering that 70 percent of ordinary people have a mortgage and large consumer loans in the form of car loans, etc., you could say that people are starving.”

“What should I do?” Irina asked. “I don't know what to do. It's not my job to decide. You need to stop the price increase and perhaps stop some policies that cause inflation.”

Factories are running at full speed to produce goods such as clothing and vehicles for the military. As a result, many workers are receiving rising wages and consumer demand is robust, further fueling the inflation fire.

Despite sanctions and shoppers angry about their grocery bills, the Russian economy remains in solid shape in many respects, growing 4.4 percent in the second quarter. The ruble has remained stable recently, having lost around 40 percent of its value against the dollar and the euro since 2022. Government finances, bolstered by oil exports, are in good shape despite increased spending, with modest deficits easily covered by loans from Russian banks.

In the long run, inflation, loss of foreign markets and foreign investment due to sanctions can lead to lower growth and income.

There is also a risk that high borrowing costs will harm Russian companies and Russian growth in the coming months.

However, central bank governor Elvira Nabiullina said there could be further interest rate hikes to reduce inflation from the current 9.1 percent to the bank's target of 4 percent in 2025.

“We believe this is achievable next year and we are pursuing the policy to achieve this,” Nabiullina said at a press conference after the interest rate decision. “We are ready to maintain restrictive monetary conditions for as long as necessary and we are also ready to raise the key interest rate further.”

She pointed to the destructive effects of too much inflation, including the loss of people's savings, high interest rates on long-term loans and mortgages, and the risk that inflation expectations become embedded in wages and prices.

Higher interest rates make borrowing and spending on goods more expensive, which theoretically reduces price pressures. Higher interest rates on savings can also encourage people to put aside their disposable income rather than squander it. So far, the central bank is fighting a losing battle, and economists say the credit crunch could eventually slow growth.

Rising wages and a strong labor market have helped shoppers offset inflation and, as a result, “consumer activity remains high,” the central bank said.

“The reason they're raising the rate is because they want to cool down a very fast-growing consumer market,” said Chris Weafer, CEO of consulting firm Macro-Advisory Ltd. “And they're afraid that if they can't slow down the consumer market, it's going to create a bubble, and then it's going to burst and put the economy in an even worse situation.”

Government revenues are supported by economic growth and continued exports of oil and gas, despite Western governments imposing less-than-iron sanctions and a $60 price cap on Russian oil. The cap is enforced by prohibiting Western insurers and shippers from trading in oil priced above the cap. Russia has been able to circumvent the price cap, however, by building its own tanker fleet without Western insurance, and reaped about $17 billion in oil revenues in July.