Ukraine to raise rates as Russia jitters weigh on currency and inflation risks

By Natalia Zinets

KYIV (Reuters) - Ukraine's central bank will likely raise its key interest rate from 9% this week to tackle worsening inflation expectations and a weakening hryvnia due to fears of a Russian military offensive, a Reuters poll of analysts showed on Tuesday.

Eight out of the 14 Ukrainian analysts expected the rate to be raised to 9.5% and the two more expected a hike to 10.0% at the central bank's monetary meeting on Jan. 20. The other four contributors believed the rate would remain unchanged.

"Rising military tensions with Russia are having a negative impact on inflation and exchange rate expectations, which has already affected the hryvnia's significant devaluation," said Kostiantyn Khvedchuk from Bank Pivdenny.

Western countries fear Russia, which has massed troops near the Ukrainian border, is preparing a pretext for a new assault on Ukraine, which it invaded in 2014.

Moscow denies plans for an attack, but said it could take unspecified military action unless the West agrees to a list of demands, including banning Ukraine from ever joining NATO.

The National Bank of Ukraine (NBU) warned at its last meeting in December that geopolitical tensions had started adversely affecting market conditions and Ukrainian assets, while fuelling demand for foreign currency from businesses and households.

The hryvnia has weakened 3.2% against the dollar since the start of 2022 despite the central bank selling $431 million during the first two weeks of January to smooth volatility on the domestic foreign exchange market.

Foreign investors shrunk their Ukrainian local bond portfolio by $210 million.

Ukraine raised its key rate five times in 2021 in a bid to clamp down on inflation, which stood at 10% in December, around twice the central bank's target level.

Khvedchuk said rising energy costs for producers and global interest rate rises were other reasons for another interest rate hike.

"Therefore, the NBU will act more decisively, raising the key rate to at least 10%," said Khvedchuk.

Oleksiy Blinov from Alfa Bank Ukraine said that the inflation trajectory remained higher than the central bank's latest forecast, prompting the bank to continue more hawkish monetary stance and increase the rate.

"Most likely, in the updated macroeconomic forecast of the NBU we will see the recognition that the return of inflation in the target corridor of 4-6% is postponed to 2023," said Blinov.

(Editing by Matthias Williams and Alex Richardson)