Ukraine central bank lowers key policy rate to 16.5%

The National Bank of Ukraine (NBU) announced on Sept.
5 that it decided to lower its key policy rate by 0.5pp to 16.5% at its
monetary policy board meeting that day. The decision extends its monetary
softening cycle resumed in July – when it also lowered the rate by 0.5pp – with the
expectation that consumer inflation will cool to a target of 5% yoy by
end-2020.

The NBU noted that July’s inflation of 9.1% yoywas above NBU projections. Meanwhile, core inflation of 7.4% yoy in July
corresponded to the NBU’s forecast. Hard monetary policy was a significant
factor that restrained fundamental inflationary pressure. At the same time,
enlarged domestic demand, alongside fast growth of wages,
impeded inflation from faster cooling.

Macroeconomic factors haven’t changed the balance of risks
for the forecast since the previous revision of the key policy rate in July,
according to the central bank. On the one hand, recent appreciation of the
national currency will foster an inflation slowdown in the nearest months. On
the other hand, swelling consumer demand, coupled with intense wage growth,
will fuel rising prices.

The NBU found that domestic political risks, which
might affect inflation, have lowered with the new session of parliamentand Cabinet appointments. These
developments create a new opportunity for activating Ukraine’s talks with IMF.
At the same time, risks persist related to lawsuits that contend against state
decisions on recovering the banking sector.

The regulator’s board might deepen cuts in the key
policy rate in case it sees the intensification of structural reforms. However,
the consistent inflation slowdown is equally important. Should inflationary
risks (in particular, high pressure of consumer demand) become realized, the
monetary softening will be more moderate.

Evgeniya Akhtyrko: The central
bank was cautious in deciding to lower its key policy rate by 0.5pp. A decrease
by 1.0pp to 16.0% would have been quite appropriate given the current level of
inflation, the continuing decline of interest rateson the local debt market, and intensified GDP growth in 2Q19.

Apparently, the fast-growing consumer demand, which
might wreck the NBU’s consumer inflation forecast for the year, is the major
point of concern in the bank’s decision-making. In our opinion, the central
bank’s 2019 inflation forecast of 6.3% YTD is too optimistic, and the actual
inflation trend in the nearest months is likely to stay above the NBU’s
projections.