The Russian central bank moved on Friday to shield the country's economy from tightening Western sanctions over Ukraine, raising its main interest rate in a bid to forestall a resurgence of capital flight.
The Bank of Russia surprises with a decision to raise its main rate by half point to 8.0 percent.
It said that "inflation risks have increased due to a combination of factors, including, inter alia, the aggravation of geopolitical tension and its potential impact on the ruble exchange rate dynamics."
The increase was the third since March as the central bank began to tighten monetary policy when the Russian economy was buffeted by the uncertainty generated by the Ukraine crisis and Western sanctions.
"If high inflation risks persist, the Bank of Russia will continue raising the key rate," it added.
Analysts polled by Interfax news agency had expected the Bank of Russia to hold its main rate steady as last week data showed that annual inflation had slowed by a tenth of a point to 7.5 percent.
The central bank said that that drop which was smaller than expected highlighted the "geopolitical risks" to higher inflation.
Neil Shearing, chief emerging markets economist at London-based Capital Economics, said that although the central bank justified its move by inflation risks "it’s pretty clear that this is a pre-emptive move to limit capital outflows ahead of possible new sanctions by the US and Europe."
Although Western sanctions were initially very limited, the United States last week slapped restrictions on several banks and companies and the EU could as soon as next week take similar moves and even move towards sector-wide measures.
- Investment hit -
But even the targeted sanctions implemented so far, along with general uncertainty, have hit business sentiment and sparked a surge in capital outflows which hit the value of the ruble and touched off a rise in inflation.
The Bank of Russia said the decision aimed to "set conditions for a decline in annual consumer price growth rates to 6.0-6.5 percent by the end of 2014 and to the target level of 4.0 percent in the medium term.
A rise in interest rates could help slow capital flight as higher returns persuade investors to keep money at home, but they can depress growth as companies and consumers have to pay more to borrow money.
The central bank noted that investment was currently being hit.
"Investment demand remains weak amid low business confidence, limited access to long-term financing in both international and domestic markets, and declining profits in the real sector," the Bank of Russia said.
- Double-digit rates? -
Shearing said Capital Economics did not rule out the Russian central bank having to raise the rate to 10 percent or more if the Ukraine conflict escalated and the ruble came under renewed pressure.
Meanwhile, the central bank also said that its estimates showed the Russian economy's growth rate to have been "close to zero" in the second quarter.
Russian officials said earlier this week that they expected that the Russian economy, which contracted by 0.3 percent in the first quarter, would dodge entering a recession by posting flat growth.
They said the government was likely to raise its annual growth forecast from the current 0.5 percent to around 1.0 percent.
The Russian economy expanded by 1.3 percent last year, a far cry from the five to 10 percent growth rates posted during much of the previous decade.
Similar to the International Monetary Fund, the Bank of Russia said that low economic growth rates are due to structural factors and reforms are needed to boost the economy.
However the Bank of Russia noted that "external political uncertainty has a negative impact on economic activity."
Citing similar reasons, the IMF on Thursday slashed its forecast for Russian growth this year, by 1.1 percentage points, to 0.2 percent.
The IMF said "activity in Russia decelerated sharply as geopolitical tensions further weakened demand."