UPDATE 2-Russian c.bank sees economy contracting by 2.4% y/y in Q1

(Adds detail on inflation expectations, liquidity surplus) MOSCOW, Feb 20 (Reuters) - Russia's central bank said on Monday it expects the country's gross domestic product (GDP) to fall by 2.4% year-on-year in the first quarter of 2023, with annual inflation standing at 3.6%. The bank this month warned that any further widening of Russia's budget deficit might compel it to raise interest rates, sending a hawkish signal as it kept the cost of borrowing unchanged but adjusted forecasts for the year ahead. On Monday, it retained its hawkish tone as it expanded on those forecasts in a monetary policy report, reiterating that a rate hike was more likely than a rate cut this year when taking into account conflicting pro-inflationary and disinflationary risks.

Annual inflation is expected to ease to its slowest pace this year in April, the central bank said, on the back of last year's high base effect, before accelerating again.

"In the subsequent quarters the impact of pro-inflationary factors will gradually increase, while the effect of disinflationary factors will decrease" the bank said in its monetary policy report.

It said the inflation expectations of Russian households would continue to significantly influence the central bank's decisions on monetary policy.

It said inflation expectations would need to return to levels seen when inflation was near the central bank's 4% target before the key rate could return to the neutral range of 5%-6%.

The bank said it expected the banking sector's structural liquidity surplus to be between 2.8 and 3.4 trillion roubles
($37.5-$45.5 billion) by the end of 2023. The 2022 liquidity surplus stood at 2.8 trillion roubles. The bank said its new forecast took into account the resumption of foreign exchange market interventions. Russia is now selling Chinese yuan to cover its widening budget deficit.

($1 = 74.7455 roubles) (Reporting by Elena Fabrichnaya; Writing by Alexander Marrow Editing by Gareth Jones)