March 4, 2021 18:39 EET

Ukraine Watch: NBU raises key rate by 50 bp to fight growing inflation

The NBU reaffirmed its monetary policy of returning inflation to the targeted corridor of 5%+/-1pp and raised the discount rate by 50 bp to 6.5%, while inflation in January was 6.1% yoy and likely to come in higher in February. This shows the end of the softening policy cycle.

Inflation and Key rate in Ukraine (%)

Ukrstat, RBI/Raiffeisen Research

Today's report states that inflation dynamics at the beginning of the year confirmed the National Bank of Ukraine's (NBU) forecast dated January 2021. However, only in 2022 inflation will start to slow down and return to the target range, as the recovery of the world and Ukrainian economies will create increased pressure on prices in 2021.
The National Bank sees the major risk for the country's economy in strengthening quarantine restrictions in Ukraine and in the world. Among other risk factors are volatility in global capital markets, deteriorating trade prices for export/import goods and military conflict.

The National Bank expects to continue the program with the IMF, in turn, excluding fiscal risks. According to our expectations, the fiscal problems that began in late 2020 have not gone away. The budget plan to finance the 5.5% GDP deficit may fail without the IMF's help, and non-resident investors assessed the negotiations with the IMF by buying local bonds with maturities of 1-2 years, indicating increased credit risks.

Since the end of 2019, the NBU started to present a forecast of the base trajectory and confidence intervals of the average discount rate, which is undoubtedly a favourable moment to build market participants' understanding of its future decisions and adjust their forecasts accordingly and determine medium-term targets. An analysis of the practice of following the basic trajectory in key rate decisions shows that they were followed precisely except for the 2nd quarter of 2020. This statement means that it is very likely that the rate will also be raised by 50 bp at the next meeting if the underlying assumptions remain unchanged.

We expect a further hike of the key rate in April and maintaining it at 7% until the end of the year. The NBU stated similar intentions to increase the key rate but mentioning that the ever-changing economic stance in Ukraine will be appropriately assessed. Thus, the central bank may change the base trajectory key rate prospects again.