INFLATION CONCERNS PROMPT SECOND INTEREST RATE HIKE OF 2010 BY CENTRAL BANK OF ARMENIA
by Venla Sipila

World Markets Research Center
Global Insight
February 17, 2010

The board of the Central Bank of Armenia (CBA) has decided to lift
the central bank’s refinancing interest rate by 50 basis points,
Reuters reports. The move takes the policy rate to 6.0%, and follows
a similar step enacted only in January (seeArmenia: 22 January
2010:). The central bank took the decision in response to accelerating
inflation, noting that the 7.0%, annual price growth seen last month
exceeded the upper boundary of the CBA’s inflation target band by 1.5
percentage points. This latest inflation result represented further
intensification in Armenian inflation pressures, after these started
to rise already towards the end of 2009, even if the average annual
inflation rate for last year had posted a relatively moderate 3.4%
(seeArmenia: 3 February 2010:and5 January 2010:). The CBA hopes that
gradual tightening of monetary policy will bring the inflation rate
closer to the central target of 4.5%.

Significance:The monetary tightening move confirms the revision in the
CBA’s policy stance; it was the second interest rate hike this year,
after three months of stable rates, following a 25-basis-point cut
in September 2009, the seventh successive easing move. However, the
main function of the Armenian policy interest rate is still that of
acting as an indicator of the central bank’s inflation expectations,
rather than being an effective monetary policy tool with any notable
impact on market interest rates and liquidity. Then again, cost-side
inflation pressures are indeed likely to increase somewhat, whereas any
notable increase in demand-side inflation is likely to take some time
to emerge, given that the Armenian economic recovery will start from an
extremely weak position. Encouragingly, the CBA has earlier indicated
that it is going to retain its flexible exchange-rate policy. This
will help in managing the still very high financial risks, related
to Armenia’s deep external imbalances, and in controlling inflation,
especially when foreign currency inflows eventually recover. On the
other hand, given Armenia’s wide external financing requirement,
the risk of potential downward pressure on the dram exchange rate
still persists, and any rapid depreciation would feed into inflation
pressures via import costs.