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Russia raises key rates, prioritizes inflation

Russia's central bank raised its key interest rates on Friday, surprising markets with a broad tightening move and signalling that it is ready to let the rouble rise to curb inflation as elections loom.

The need to raise rates, the central bank said, came as an increase in consumer prices has proven to be more than just a short-term supply shock caused by last summer's drought, which killed a third of the country's harvest.

"The decision was taken in connection with the persistent level of high inflation expectations, which exceed targets for this year," the central bank said in a statement.

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Although inflation has stabilized somewhat, it remains perilously close to double digits at 9.6 per cent - above the official target of below 7 per cent by the end of 2011.

Inflation has been become an increasingly political issue as Russia prepares for parliamentary elections in December and a presidential poll next spring in which Prime Minister Vladimir Putin or President Dmitry Medvedev may run.

"Probably, a decision that fighting inflation is the priority ahead of elections was taken at the top level," said Dmitry Polevoy, an analyst at ING in Moscow.

The Bank of Russia said it would raise its refinancing rate, overnight deposit rates and a series of other rates by 25 basis points, effective May 3.

By raising the benchmark refinancing rate - which has no direct impact on rouble liquidity - the central bank signalled its concern about inflation and willingness to tame it, even if this means a stronger currency.

The rouble hit a fresh 2-1/2-year high against the dollar on the news. The currency has firmed 11 per cent versus the greenback already this year, pushed up by rallying oil prices.

"The central bank decided to take a pre-emptive step," said Olga Sterina, an economist at UralSib in Moscow.

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"Everything is directed to battling inflation."

The central bank's gradual monetary tightening has been accompanied by other administrative measures, such as clamping down on gasoline prices and a ban on grain exports - all aimed at keeping prices low and voters happy.

But some of the measures have started backfiring.

Russia, the world's largest oil producer, faces a regional fuel supply crisis blamed by the industry on regulatory pressure on pump prices, forcing Mr. Putin on Thursday into a hurried move to hike gasoline export duties to keep more fuel in the country.

The central bank warned that future decisions will have to balance out the needs to tame inflation, spur economic growth and avoid excessive rouble appreciation.

"Further steps regarding changes in the monetary policy of the central bank will depend on the balance between the risks of inflation pressures and slowing economic growth," it said.

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A Reuters poll this week showed most economists had expected the central bank to raise overnight deposit rates by 25 basis points to 3.25 per cent, while keeping the refi rate on hold at 8.00 per cent.

"The central bank will need to raise deposit rates more aggressively than lending rates in the future (cumulative 100 bps for the year) in order to tighten the interest rate corridor and thus make monetary policy more effective," said Aurelija Augulyte, an analyst at Nordea.

Against analyst expectations, the bank did not raise minimum reserve requirements on bank liabilities this time, after increasing them for the three previous months. Augulyte said she expected reserve requirements to be raised in the coming months.

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