Friday was a rather extraordinary day for world markets. As I discussed then there was the Bank of Japan emerging from its eyrie in kamikaze fashion as it pressed the monetary accelerator pedal to the metal. But I wish to move to a particular comparison where the consequences of its actions pushed the Yen lower. Overnight it dropped to 113 versus the US Dollar,141 versus the Euro, and over 180 versus the UK Pound for falls of the order of 3%.
Meanwhile a near neighbour of Japan across the sea of Japan took the opposite attitude to currency weakness as we saw the Bank of Russia do this.
On 31 October 2014 the Bank of Russia Board of Directors decided to raise the Bank of Russia key rate to 9.5 percent per annum.
This is a completely different attitude to Japan which is trying to drive interest-rates and yield ever lower. Indeed fans of the current economic mantra of ZIRP (Zero Interest-Rate Policy) were probably singing along with REM at this point.
It’s the end of the world as we know it
It’s the end of the world as we know it
Why did the bank of Russia do this?
If we investigate its explanation we see the following.
According to the Bank of Russia estimates, inflation will remain above 8% till the end of 2014 and in 2015 Q1. Continuing high growth of consumer price will result in persistent increase in inflation expectations creating additional inflation risks. The Bank of Russia will continue to take measures aimed at slowing down consumer prices growth to the target of 4% in the medium run.
Such a forecast only reinforced the current state of play regarding consumer inflation in Russia.
According to the estimates as of the 27 October, annual consumer price growth rate was 8.4%. Core inflation rose to 8.2% in September 2014. Acceleration of inflation was mainly provoked by accelerated price growth for food items from 10.3% in August to 11.4% in September.
So as has been discussed and expected on this blog inflation is raging in Russia caused in essence by the fall in the value of the Ruble. The Bank of Russia estimates that it has added 1.3% to consumer inflation which personally I would say is on the low side. It also musters up its courage and points out that the restrictions on food imports imposed by President Putin have added 1.2% to consumer inflation.
That word “temporary” again!
If we go back to March of this year the Bank of Russia told us this.
The Bank of Russia Board of Directors decided to temporarily increase the Bank of Russia key rate to 7.00%.
Although of course it a way they were right about it being temporary as they later raised it to 8% and now 9.5%! There was a clear implication back then that the next move would be down and not up. Yes one more time we see that up is the new down.
What is really behind this?
In essence the central bank is responding to the fall in the Ruble which at times has become a plummet. Back in March the Bank of Russia was trying to behave in pre-emptive fashion but now it is facing a currency which was at 34 to the US Dollar at the beginning of July and is now at 43.3 for a fall of 27%. This makes all sorts of products and commodities more expensive and has stoked the inflationary fires. Of course Russia has resources such as oil but it still needs to import other goods and there is the problem.
Does the central bank playlist ever work?
Extremely rarely is there any success to be found here. The issue is that it finds itself doing what it should always be doing its best to avoid which are operations in extremis. If we consider an interest-rate rise of 2.5% that is substantial especially in these times but it is dwarfed by the 27% fall in the currency. It is invariably like that and even if we imagine a scenario where a central bank stepped up on the same scale then an interest-rate rise of that magnitude would lead to expectations of economic collapse and so the currency would probably be sold anyway! I tend to feel that the larger the interest-rate rise the less likely it is to work as psychology – why is it necessary?- works against it.
Currency intervention has a similar problem in that world markets are so large that they are likely to dwarf whatever resources the central bank can throw at them. Also the larger traders may welcome central bank intervention as it may allow them to increase the quantity they can sell. Oh what a tangled web and all that. If you are ever in such a situation as I was back in 1992 as the UK was ejected from a forerunner of the Euro you see that the what the central bank was confident about only five minutes earlier disappear in King Canute fashion. Once that happens a few times it starts to look at its rapidly dwindling reserves and depending on the quality of its individuals either start a rethink or panic. The UK saw the latter first and the former second back in 1992.
A sort of irony here is that the Bank of Russia started from a relatively strong intervention position as via the country’s oil and commodity resources it has reserves to use. But we observe that the “It won’t make any difference” statement by Newt in the film Aliens applies one more time. Currency intervention has turned out to be like trying to catch a falling piano one more time.
What about the Russian economy?
Any Russian statistician who goes to the Kremlin with paperwork suggesting an economic contraction is either very brave or foolish or both! However the Bank of Russia has edged near to the mark.
According to the Bank of Russia estimates, economic growth rate in 2014 Q4 and 2015 Q1 will be close to zero.
If we look at the domestic economy there are considerable grounds for expecting not only a slow down but a sharp one. Let us start with this.
accelerated price growth for food items from 10.3% in August to 11.4% in September.
If we ignore the usual central banking mantra that food is “non-core” and instead regard it along with energy,water and shelter as being vital we see that a squeeze is taking place on real income in Russia. Also a type of credit crunch is being applied.
According to the estimates, annual money supply (M2) growth rate decreased from 16.1% on 1 October 2013 to 7.4% on 1 October 2014.
Funds (as defined by M2) are now falling in real terms as opposed to quite a substantial rate of growth.
Something that is ever more familiar as we look around the world is at play in Russia now. From the Moscow Times.
In their first decline for five years, real wages in Russia fell 1.2 percent in August, hollowing out the spending power of Russian consumers amid an economic slowdown that shows no sign of quitting, business newspaper Vedomosti reported Monday, citing data from Russia’s statistics agency, Rosstat.
Next year’s budget plans to raise civil servant salaries by on average 5.5 percent.
So should inflation continue on its current path there will be real wage falls of 2/3% for civil-servants in Russia.
Also the parts of the Russian economy which rely on the oil price will have been grimly watching its recent decline. A price of US $86 for a barrel of Brent Crude Oil compares with one a year ago of more like US $106. Of course Russia gets more Rubles per dollar now,except of course they buy less as inflation picks-up. Quite a spider’s web there but the Russian economy is the fly caught in the trap. The offsetting impact of higher export demand faces a few problems, not the least of trying to expand oil and gas production into a falling-price environment.
There is much to consider here as resources rich Russia faces a sort of (resources poor) Japan in the mirror situation. It has resources and inflation and even had real wage growth all of which Japan wants. However for different reasons they are both in economic trouble right now with the one thing they share being a declining currency.
Meanwhile someone somewhere is probably thinking up a new version of the currency carry trade. You would borrow in Yen for 0% and lend in Rubles at 9.5% in stereotypical terms. It would of course require a lot of bravery to do this but if you are either brave or desperate you may see it as worth a go. What could go wrong?
Some of the issues here are off my beat as they are plainly political and some are military as the Russian bear flexes his muscles. But it is hard to avoid the feeling that a people used to hardship are about to see some more of it.
More evidence that the UK is now a bankocracy
State-backed Royal Bank of Scotland Plc has signed an agreement with the City of London Police to help them with free training and advice on financial crime in a deal to be announced on Monday, the Financial Times reported.