April 15 (Bloomberg) -- The hryvnia rallied after Ukraine’s central bank raised interest rates by the most since 1998 to stem the world’s worst selloff this year. Government bonds dropped amid a military confrontation in the country’s east.
The currency strengthened 6.7 percent, the most since March 4 on a closing basis, to 11.9000 per dollar at 6:34 p.m. in Kiev, paring this year’s slump to 31 percent. The central bank increased its key rate by 3 percentage points to 9.5 percent yesterday. Government bonds reversed earlier gains, sending the yield on the dollar-denominated debt due April 2023 up 11 basis points to 9.99 percent, the highest since March 20.
The rate increase, the first in six years and the biggest since Russia’s debt default in 1998, was aimed at stemming currency declines that threaten to spur inflation and disrupt money markets. Ukraine unleashed an offensive to dislodge militants from towns in its eastern Donetsk region as the authorities in Kiev said elements of Russian special forces were identified among the anti-government forces.
While the rate move boosts confidence in the central bankers in Kiev, it won’t help against the “unavoidable depreciation pressure” from the escalating political and military conflict, Ulrich Leuchtmann, a Frankfurt-based analyst at Commerzbank AG, said by e-mail today. The economy faces a “deep recession,” he said.
Four militants were killed and two wounded when Ukrainian troops stormed an airport in Kramatorsk, taking it under control, Russia’s state-run RIA Novosti news service reported. Ukraine is on the brink of civil war and “that’s scary,” Russian Prime Minister Dmitry Medvedev said at a meeting with his counterparts from Belarus and Kazakhstan.
The hryvnia has still lost the most this year among more than 170 currencies tracked by Bloomberg. The central bank has said it stopped intervening to prop up the currency in February as reserves plunged to a nine-year low of $15.1 billion from $31.7 billion in April 2012.
Six-month non-deliverable forward contracts on the hryvnia, which investors use to speculate on or hedge against the currency, strengthened 3.8 percent from the weakest close on record to 13.35 today, reflecting a 10.9 percent depreciation in the period, according to data compiled by Bloomberg.
While “there may be some investors coming back on the margin initially,” there won’t be any affect “in the intermediate term,” Neil Azous, founder of Stamford, Connecticut-based research firm Rareview Macro LLC, said in an e-mail yesterday.
Policy makers also raised the overnight rate on refinancing loans secured with Ukrainian state securities to 14.5 percent from 7.5 percent and its rate on overnight certificates of deposit to 4.5 percent from 1.5 percent.
“The board seeks to strengthen the national currency” by raising rates, Ukraine’s central bank said in a statement. “It aims to restrict inflation and balance the situation in the money market.”
Inflation in Ukraine accelerated to 3.4 percent in March from 1.2 percent the previous month. The nation’s economy will contract 3 percent this year, according to the median of 19 forecasts compiled by Bloomberg.
Another 150 basis-point to 250 basis-point increase in rates is “completely realistic” since Ukraine has little scope to draw on reserves to protect the currency, Dmitri Petrov, a London-based analyst at Nomura Holdings Inc., said in response to e-mailed questions today. Domestic investors were the main drivers of the currency’s rebound today, he said.
Ukraine sealed a preliminary accord with the International Monetary Fund last month for as much as $18 billion in loans over two years, with the agreement unlocking $27 billion in international financing. The eastern European country needs about $30 billion through 2015 to “balance the situation,” Finance Minister Oleksandr Shlapak said in an interview in Washington on April 10.
Ukrainian units backed by armored personnel carriers blocked all approaches to the town of Slovyansk today, RIA Novosti reported, citing an a pro-Russian activist, Sergey Tsyplakov. Part of Russia’s 45th Airborne Regiment was spotted in both of the towns, Ukrainian First Deputy Prime Minister Vitali Yarema said on Channel 5.
Policy tightening threatens to deepen Ukraine’s recession, with more rate increases on the horizon if the political crisis keeps market conditions “fragile,” Neil Shearing, a London-based analyst at Capital Economics Ltd., wrote in an e-mailed report today.
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