Ukraine central bank retains key rate, sees higher inflation risk

The board of directors of the National Bank of Ukraine
(NBU) announced it kept its key rate unchanged at 12.5% at its Sept. 14
meeting. In its statement, the NBU explained its decision as the need to bring
inflation back to its “targeted trajectory.” The regulator also said that its
end-2017 CPI target of 9.1% YTD is not realistic anymore (offering no new
estimate) and revealed its expectation that CPI will converge to its targeted
trajectory in 2Q18 (when it sees CPI at 7.0% yoy).

As in its August statement, the NBU said it will
return to easing monetary policy only upon receiving clear signals of leveling
inflation risks. This time, the NBU warned that it may also have to increase
its key rate in case inflationary pressure intensifies from the demand side (in
case of inadequate increases in social standards) and if inflation expectations
worsen. The central bank has scheduled the next revision of its key rate for
Oct. 26.

Alexander Paraschiy: This was
the third NBU meeting in a row at which it decided to keep its key rate
unchanged, after it lowered it by 0.5pp in May 2017 (and by a total of 1.5pp
since the year’s start). And this is the first time in at least two years in
which the NBU explicitly has mentioned the possibility of raising its key rate
in the near future. It is clear that the NBU’s 2017 CPI target will be
significantly off (we expect CPI will reach 11.8% YTD by the year end), but so
far we see no reasons for the NBU to raise the key rate. 

There is a risk related to UAH 61.2 bln stashed at the
Treasury accounts (as of Sept 1). We expect public spending will speed up in
the coming months, increasing pressure on the hryvnia and adding fuel to
demand-driven inflation. If that factor indeed becomes sensitive to price
dynamics, the NBU likely will start tightening monetary policy.

Another factor that may drive the rate hike is
Ukraine’s failure to agree with the IMF on a fifth loan tranche under the USD
16.8 bln EFF program in the next month. The NBU has scheduled its next board
meeting for end-October. By that time, it will be clear how Finance Ministry
will manage the issue of accumulated cash at the treasury account. 

Should it occur that the Finance Ministry still delays
with spending, making one-shot outlays likely in December, we will see the NBU
tightening liquidity to prevent a negative effect from fiscal policy.