October 30, 2017 | Cbonds
|During the last MPC meeting NBU decided to raise its key policy rate by 100 b.p. to 13.50%, which came as a surprise to local markets, despite the fact that regulator mentioned this possibility during the latest inflation release. We read this move as a signal to other centers of economic policymaking and to IMF, rather than move to sustain inflation, which is poised to remain well above NBU targets in 2017 (we expect 13.0% vs 8.0% target) and in 2018 (9.0% vs 6.0% target). Simultaneously, the rate increase will help to keep local currency in the short run and decrease additional price risks stemming from UAH devaluation.|
The decision to increase the key policy rate comes for the first time since early March 2015, when NBU had to hike the key rate to 30% to stabilize local currency which was falling off the cliff at that time. Ukrainian troops just suffered Debaltsevo debacle, international reserves were close to USD 5bn and IMF program had yet to begin. Ever since that time, regulator was cutting the interest rates, having implemented a new monetary policy design and developed decision making based on inflation expectations.
Headline inflation has been disappointing recently, having risen by 2.0% m/m in September. In y/y terms, prices grew by 16.40%, which is more than two times of NBU target for 2017. The key inflation drivers were primarily food prices which have increased against the backdrop of poor vegetables harvest and accelerated exports of meat products which pulled domestic prices up to international benchmarks (please read the detailed inflation analysis in our Weekly report dated October 10th). This dependency on food prices makes inflation in Ukraine one of the most volatile in the region (CPI ranged from negative values to 60% y/y over the last five years).
While the main inflation drivers YTD were transitory, in our view, elevated inflation levels gradually become more entrenched and lead to gradual worsening of inflation expectations. In a press release following MPC decision, NBU cited worsening of inflation expectations in September-October. This comes against backdrop of ever rising labor costs for Ukrainian enterprises which faced significant labor force shortages, driven by migration to neighbouring countries (initially to Poland, and after introduction of visa-free regime in the summer of 2017– to other EU countries).
Demand side inflation drivers are in the front seat going forward. Following twofold increase of minimum wages since Jan 2017, which had added 2 percentage points to annual CPI growth, in our view, Ukraine's government is implementing ambitions social spending increase. These spending spree might become even more aggressive in 2018 and 2019 as Ukraine approaches Presidential and Parliamentary elections. Luckily, Ukraine is running primary fiscal surplus, and enjoys solid revenues growth (For 9M17, central budget revenue reached UAH 585.8bn vs UAH 407.6bn a year ago).
The move will help to stabilize local currency at current levels, by spelling somewhat higher UAH domestic rates, making it more profitable to keep funds in hryvnia both for domestic agents, but also for non-resident investors who recently displayed some demand for UAH based instruments. It is worth to note that domestic depositors faced the historic fall in deposit this year following nationalization of the largest bank in the country and subsequent coordinated decrease of deposits by state banks.
Is the main purpose to send a signal to other economic policymaking centers in Ukraine? First, local media report that appointment of a new NBU head (which yet has to officially replace Mrs Gontareva) is finally a done deal, citing current acting NBU governor as most probable successor. Second, NBU and government has just completed a reprofiling of domestic debt in early October, having issued UAH 220 bn in new bonds (UAH 145 bn - in inflation-linked securities). That is, NBU as a strong argument of securing lower long term debt service costs for the government vs one-off likely increase in debt service costs during the next auctions. Such reprofiling, coupled with uneven budget spending, bears risks of significant UAH rate fluctuations, if saved funds come in bulk to the banking sector. Last but not least – it is a strong message to emphasize the importance of IMF program continuation. The expectations of the next disbursement are now widely shifted to 2018, and it is crucial that Ukraine does not return to practice of «printing money», which could jeopardize macroeconomic stability, even though level of international reserves is at much higher level today (USD 18.6 bn as of Oct 1st).
What's next? Near term policy space of NBU is very limited, in our view. We think that inflation readings in the last quarter will be more favorable, allowing CPI to do down by three and a half percentage points from current level until year end. This should make NBU more comfortable with inflation prints and prevent further hikes, unless uneven liquidity supply from a treasury account destabilizes FX rate significantly in December. At the same time it would be difficult to motivate further increase in key rate, especially as we understand that the key inflation drivers stem from the developments, not dependent on NBU interest rate policy. All in all, our current expectation is no change over the next few MPC meetings in Q4 2017 and Q1 2018.
|Full company name||PJSC "UkrSibbank"|
|Country of risk||Ukraine|