NBU keeps key policy rate at 18%, hikes consumer inflation forecast

The National Bank of Ukraine (NBU) decided on Oct. 25
not to change its key policy rate of 18% after two consecutive hikes by 0.5pp
on July 12 and Sept. 6, it announced in a press release following its board
meeting. The central bank considers current monetary conditions “tight enough”
to slow inflation to the mid-term target rate of 5% in 2020.

The NBU noted that September consumer inflation
amounted to 8.9% yoy, exceeding the upper end of the inflation target rate of
4.5-8.5% for that period, as well as the NBU’s forecast of 8.3% yoy. The
regulator mentioned high core inflation (8.7% yoy in September) as a factor
hindering a reduction in consumer inflation.

In particular, high consumer demand, coupled with
rising production costs, continue to put pressure on prices. In addition, the
hryvnia devaluation in July-August inflated prices for imports. On top of that,
a surge in global oil prices led to higher fuel prices in Ukraine. The NBU also
cited the factor of approaching presidential and parliamentary elections in
2019 as keeping inflationary expectations high, both among individuals and
businesses.

Consumer inflation will continue to slow, the central
bank said, but achieving the inflation target will take more time than was
initially expected. The NBU revised upward its 2018 consumer inflation forecast
to 10.1% yoy from 8.9% yoy. With this revision, the NBU expects inflation to
reach the upper end of the target range – 6% – in 1Q20 (instead of 4Q19, as
previously expected), while the mid-term inflation target of 5% will be reached
by the end of 2020. Consumer inflation in 2019 will amount to 6.3% yoy,
according to the NBU.

The regulator is confident that tight monetary
conditions created by the previous key policy rate hikes will be the major
factor in inflation slowing further. The NBU also expects the commercial banks
to raise interest rates for deposits, which should result in higher propensity
to save among individuals.

The NBU expects Ukraine’s GDP to grow 3.4% yoy in
2018. Meanwhile, economic growth will slow to 2.5% yoy in 2019 as a result of
the global economy cooling, prices deteriorating on external markets, prudent
fiscal policy, and tight monetary policy. In 2020, economic growth will
accelerate to 2.9% yoy due to a less stringent monetary policy and improved
investment attractiveness.

The key assumption of the NBU’s forecast is Ukraine’s
continuing cooperation with the IMF under a new stand-by program. The major
risks of the central bank’s forecast include the growth of inflationary
expectations related to the new political cycle, as well as deterioration of
external economic conditions.

Evgeniya Akhtyrko: By abstaining from raising the key policy rate amid intensified inflation,
the NBU acknowledges the limited influence of monetary policy tools to control
consumer inflation at this moment. At the same time, hiking the key policy rate
when Ukraine is promoting a new Eurobond placement on external markets would look illogical and would
raise questions among potential investors. In addition, the recent positive
developments in Ukraine-IMF talks severely reduced Ukraine’s macroeconomic
risks for 2018-2019, providing the main basis for the NBU’s decision.