Ukraine central bank lowers key policy rate to 17%, upgrades macro forecast

The National Bank of Ukraine (NBU) announced on July
18 that it had decided to lower its key policy rate by 0.5pp to 17.0% at its
monetary policy board meeting that day. After having kept it unchanged at 17.5%
since April, the central bank now goes on its policy of monetary softening, as
it sees the trend of inflation cooling towards the NBU target of 5% by
end-2020.

 

The NBU notes that June’s inflation of 9.0% yoy
approached the NBU’s projections. Core inflation slowed to 7.4% yoy in 2Q19,
which is also close to the central bank’s forecast. Hard monetary policy was a
significant factor that restrained fundamental inflationary pressure. At the
same time, consumer inflation remained relatively high, being fueled by
consumer demand, increased costs of production and the growth of
administratively regulated prices.

 

The central bank confirmed its 2019 inflation forecast
of 6.3% YTD.

 

Even with the lowered key policy rate, the monetary
conditions will remain relatively hard. The NBU believes that high interest
rates will fuel the demand for UAH-denominated securities, which in turn should
contribute to the stability of the exchange rate. In addition, such policy
should restrain the pressure from consumer demand.

 

The central bank improved its forecast of GDP growth
to 3.0% yoy in 2019 (vs. 2.5% yoy in April’s forecast) and to 3.2% yoy in 2020
(vs. 2.0% yoy in April’s forecast) expecting stronger domestic demand, better
terms of trade and an increased grain harvest. The NBU also expects that the
deficit of the current account will shrink to 2.6% of GDP in 2019 due to a high
grain harvest, lower prices for energy resources, and lower volume of dividends
repatriation. In 2020-2021, the deficit of current account will enlarge due to
expected drop in natural gas transit, worsened terms of trade and increased
consumer and investment imports.

 

According to the NBU’s base scenario, the key policy
rate will decrease to 8% given sustainable decrease of inflation to a 5% yoy
target.

 

The key assumption of the NBU’s forecast is Ukraine’s
continued cooperation with the IMF in which case the country’s gross
international reserves will reach USD 23 bln in 2021. The NBU cited the delay
of key reforms and leveling of positive achievements of the past years as a
major risk to its projections.

 

Evgeniya Akhtyrko: The NBU’s
decision to lower the key policy rate was expected given the significant
improvement in market sentiment. In particular, the significant decrease of the
interest rate for local bonds on the primary market amid stable demand
indicated that the key policy rate of 17.5% was too high for the current
economic conditions.

 

Meanwhile, the improved sentiments were largely
related to the removed negativity rather than to affirmative positive
statements of the new presidential administration in Ukraine. Indeed, the
market is still waiting for more moves towards cooperation with the IMF and the
commitment of the new administration to consistent large-scale reforms.

 

The update of the NBU’s macroeconomic forecast is
quite bold. We are concerned about the central bank’s point regarding the grain
harvest as a major driving force of economic acceleration through the end of
the year. Even with a grain harvest comparable to last year’s record-high
result, the overall contribution of the agricultural sector to economic growth
will be lower than in the previous year. In addition, the performance of the
manufacturing sector remains very poor (0.9% yoy growth in 5M19) and is not likely to show a significant
break-through in 2H19.