NBU hikes key rate amid worsened view on IMF loan, inflation

The board of directors of the National Bank of Ukraine (NBU) ruled on Oct. 26 to raise its key rate by 1pp to 13.5%, according to its report the same day. The regulator expects that its tightened monetary policy will enable maintaining consumer inflation at its targeted level in 2018. The NBU also worsened its consumer inflation outlook to 12.2% as of end-2017 (from 9.1% previously) and to 7.3% as of end-2018 (from 6.0% before).

Ukraine’s central bank also revealed its expectation that Ukraine will receive its next IMF tranche under the EFF program in 1Q18 only (after assuming two tranches this year), and a possible subsequent tranche in late 2018. On a positive note, the NBU upgraded its estimate of Ukraine’s real GDP growth to 2.2% in 2017 (from 1.6% estimated before) and to 3.2% in 2018.

The NBU identified two major risks for its outlook: a possible “increase in social standards” and a “delay with official financing under the IMF program.” It does not rule out a further rate hike in case these risks materialize, and it expects to switch to monetary easing closer to the end of 2018 in case of Ukraine’s “further cooperation with the IMF” and adopting a “weighed fiscal policy,” which we understand to mean restricting populist policies during the election campaign season. 

Alexander Paraschiy: The market consensus was that the regulator would keep its key rate unchanged since the current inflation stems from food prices and monetary tightening would change nothing in this trend. In our view, the fact that the inflation target was already missed (the NBU targeted 8% +/- 2pp for 2017 while CPI already reached 10.2% YTD for 9M17) probably prompted the rate hike.

Also, it is likely that the NBU’s sharp move was a signal for vigilance for the Ukrainian government, which has relaxed after it managed to attract USD 3 bln from its September Eurobond placement, now feeling less pressure to rush with implementing IMF demands to get the next loan tranche.

We don’t rule out the NBU raising the key rate one more time in December if the government takes more populist moves, such as hiking minimal wages in Ukraine. At the same time, we expect the regulator will return to a policy of rate cuts as soon as inflation starts to ease, which we expect could happen in 1Q18 or 2Q18.