In conjunction with annual inflation exceeding over 7 pct in August which is at risk and the threat remains that it will top the 4 pct target next year, Russia’s central bank (CBR) is expanding its efforts to mop up surplus liquidity with an instrument it hasn’t used for more than a year.

Instead of providing money to lenders at a regular repurchase auction, the central bank on Tuesday will offer to store 100 billion rubles ($1.5 billion) of funds for one week, paying as much as 10.5 pct in interest. The deposit auction is the first since February last year, central bank data show.

“The central bank printed rubles and now wants to soak up the excess to prevent inflation from picking up,” said Fitch Ratings analyst Alexander Danilov. “Previously they’ve been providing liquidity by giving repo loans for the last several years.”

Price growth slipped in July to 7.2 pct from a year earlier, the slowest in more than two years.

The liquidity glut has pushed money-market rates below the central bank’s benchmark. The Ruonia overnight rate has averaged about 10.8 pct this year, down from more than 17 pct at the start of 2015. It reached 9.93 pct on July 4, the lowest since December 2014. 

The central bank has cut its benchmark once in the past year, lowering it to 10.5 pct in June. The ruble traded little changed at 64.5825 per dollar as of 11:47 a.m. in Moscow.

Monday’s decision to switch to a deposit auction was due to the expected “inflow of liquidity in the banking sector via the budgetary channel at the start of August,” the regulator said in its statement. “Demand for liquidity has fallen, while supply has increased.”

Hedging Strategy (USDRUB):

We kept urging for dollar’s hedging against ruble since March, below is an instance where we’ve advocated the option strategy at spot ref: 68.86 then and now trading at 64.8485, please follow the below weblink for more reading on this.

http://www.econotimes.com/FxWirePro-Gradual-Russian-GDP-in-H2-and-rising-inflation-Ruble-likely-to-gain-further-USD-RUB-hedging-perspectives-184370

At spot ref. 64.8485: we still like to continue with the same recommendation either long in 2m/1w diagonal USD/RUB put spread or shorts in near month futures, the RUB recovery now look too extended for a put position vs. the USD as from current levels we see only contained a further potential for RUB gains.

A 66.75/62.50 diagonal put spread is likely to fetch for certain yields of the USD notional as it edges above up to higher strikes in next 1 week or so and slides as much as possible up to maturity on longs.

The risk is dubiously unlimited in shorts, the structure should benefit from a further compression in RUB volatility in a bullish scenario.