Ukraine's central bank announced plans Wednesday to set its highest discount rate in more than a decade to rein in soaring inflation and calm investors who are taking their money abroad.
The surprise decision to raise the main lending rate to 12.5 percent from 9.5 percent effective Thursday comes just weeks after the economy skirted imminent bankruptcy thanks to the promise of immediate international aid.
But an escalating pro-Kremlin insurgency in Ukraine's economically vital eastern industrial basin appears to have to have scared Western investors and put pressure on the ex-Soviet country's currency.
The National Bank of Ukraine (NBU) said consumer prices could grow by 17 percent on an annualised basis this year.
It noted that the rate had jumped to 12.0 percent in June from 0.5 percent in January -- a month before the ouster of a Moscow-backed leader prompted Russia's seizure of Crimea and encouraged the separatist revolt.
The central bank noted that the jump in prices "was anticipated, considering the weakening of the hryvnia (local currency) exchange rate, the start of economic reforms... and the continuing tensions in the east."
The bank had already hiked its reference refinancing rate to 9.5 percent from 6.5 percent in April.
"The timing of the decision to raise interest rates comes as something of a surprise... One explanation is that capital flight may have accelerated in recent weeks as the conflict in the east of the country has escalated," the London-based Capital Economics consultancy said in a research note.
Ukraine's Western-backed leaders breathed a sigh of relief on May 1 when the International Monetary Fund offered Kiev a two-year $17.0-billion (12.6-billion) loan backed by another $10 billion of global funding.
"Taking a step back, though, the key point is that even with an IMF deal in place, Ukraine’s balance of payments position remains extremely fragile," Capital Economics observed.
- IMF rescue pain -
Analysts attribute the elevated inflation expectations in part to painful but long-overdue economic restructuring measures demanded as part of the IMF rescue deal.
These include the gradual removal of budget-draining social benefits and subsidies that have survived since the Soviet era for basic utilities such as electricity and water supplies.
But higher interest rates are a double-edged sword that can both slash inflation and puncture growth rates by slowing bank lending and economic activity as a whole.
The IMF already expects Ukraine's economy to contract by five percent this year. The 46-million-strong nation's gross domestic product finished last year flat and expanded by just 0.2 percent in 2012.
Capital Economics said growth data for April through June that will published at the end of the month should show output shrinking by three percent in annual terms.
"And it seems highly unlikely that there will be a meaningful recovery over the rest of the year," it observed.
Kiev's Razumkov Centre economic programmes director Vasyl Yurchyshyn said the central bank should be trying to stimulate demand by expanding the supply of money available to businesses and consumers.
But he added that the bank's current focus on fighting inflation might be misguided because its future rate will depend on the pace at which subsidised prices are removed -- not the currency devaluation that caused consumers to pay more for goods in the past few months.
"Higher housing and utility service prices cannot be counteracted through cental bank discount rates," Yurchyshyn said in a telephone interview.
"So I doubt that this huge hike in the discount rate will help slow inflation. But it could limit the expansion of Ukraine's money supply."