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Speech by NBU Governor Yakiv Smolii at a press briefing on monetary policy

Dear colleagues,


I would like to inform you that the Board of the National Bank of Ukraine has decided to hike its key policy rate to 17.5% per annum, effective from 13 July 2018, aiming at bringing inflation back to the target range in 2019.


The NBU believes that a number of factors can pose a threat to inflation decreasing to the target level – namely:


a continued pickup in domestic demand


active labor migration


higher risks to receiving the next tranche from the International Monetary Fund and other related financing


excessively high inflation expectations


lower investor interest to assets of developing countries.


A tighter monetary policy will neutralize their effect, driving inflation down to 5.8% as of the end of 2019 and 5% in 2020.


What inflation developments followed the last key policy rate decision?


In June, inflation decelerated markedly to 9.9% yoy, which was somewhat below our April forecast. This was primarily the result of a considerable increase in supply of food products on the back of more favorable weather and a rise in imports.


Moreover, FX market conditions were benign. The economic upturn in Ukraine’s main trading partners, high prices for Ukrainian exports, the tight monetary policy, and supply of foreign currency from banks made the hryvnia strengthen both against the US dollar and the currencies of the trading partner countries. This, in turn, influenced the costs of imported goods and the prices of goods and services costs of which heavily depend on imports.


Core inflation also decelerated in June, to 9.0% yoy that was lower than expected. However, core inflation remaining high indicates that the underlying inflationary pressure is persistently strong.


This is mainly the result of a sustained pickup in consumer demand, which is fueled by a rapid rise in household income that substantially outpaces the rates of economic growth.


First, this was due to the growth in wages.  In May, the average nominal wage in Ukraine was 28% above the level of May 2017, largely on the back of active labor migration and robust labor demand. The seasonally adjusted unemployment rate declined in Q1, for the first time since 2016.


Second, inflows of remittances continue to grow rapidly. In January–May, they exceeded the last year’s level by 30% and reached USD 4.5 billion.   This is attributed to further growth in the number of labor migrants and an economic revival in Ukrainian migrant’s destination countries.


Third, fast growth in social benefits spurred household income.


Will inflation continue to decrease?


We expect inflation factors to become stronger in future. A faster-than-expected disinflation in May–June 2018 will be neutralized in the second half-year.


This is due to expectations of a greater-than-expected increase in administered prices at the end of the year, which is aimed at bringing domestic gas prices closer to the import parity price. Subsequently, the related utility services prices will also rise.


This factor will also influence inflation levels in the first three quarters of the next year, which will not allow the NBU to bring inflation to the target range before Q4 2019. However, this factor is beyond the reach of monetary policy and thus monetary policy tools cannot be used to neutralize it.


At the same time, in H2 2018 and 2019 inflation will be exposed to a number of factors that should be eliminated by monetary policy tools, unlike the rise in administered prices. Among them:


higher-than-expected domestic demand, which is, among other things, due to wage growth and greater remittances from labor migrants


less interest on the side of investors in Ukrainian sovereign debt as a result of the global trend of exiting developing countries’ assets and postponed financing under the IMF cooperation program


inflation expectations that continue to exceed the NBU’s inflation targets.


These are the factors, which the Board aims to address with today’s decision to hike the key policy rate.


Under such conditions, the tighter monetary policy will be among the key factors to drive inflation down. Therefore, we keep the inflation forecast unchanged at 8.9% at year-end 2018 and 5.8% at year-end 2019.


We expect that the tight monetary policy will bring inflation to the target range in Q4 2019. In 2020, inflation will decelerate to 5.0%, reaching the midpoint of our target range (5.0% ± 1 pp).


The NBU believes that the forecast of 2018 real GDP growth of 3.4% is still relevant.


Private consumption will remain a major driver of economic growth. In the current year, private consumption will be fueled by the persisting high rate of growth in real wages on the back of high migration.


Meanwhile, favorable terms of trade, a recovery in the industrial sector, together with greater access of Ukrainian exporters to foreign markets, will decrease the negative contribution of foreign trade to GDP.


However, real GDP growth will decelerate to 2.5% in 2019. This will be due to the waning effects of higher social standards and the tight monetary conditions required to bring inflation back to its target. The NBU believes that fiscal policy will also be tighter because of the need to repay large volumes of public debt.


In 2020, the real economy is expected to grow by 2.9%.  Private consumption will remain the main driver of economic growth in the medium-term.


Private consumption will be also buoyed by rising migrant remittances, thanks to an increase in the number of labor migrants.


At the same time, the increase in the number of labor migrants will have a reverse effect by forcing companies to raise wages, thus narrowing their ability to increase investment.


The external trade deficit will persist, if not widen, as imports will satisfy a significant portion of domestic consumer demand and capital investment needs.


A key assumption of the above scenario is based on Ukraine continuing to carry out structural reforms, as provisioned in the IMF-supported program.


These reforms are essential to delivering macrofinancial stability and sustainable economic growth in the long-term. Access to the official financing provided by the IMF and other international lenders will enable the government to secure financing on the international capital markets on reasonable terms.


The NBU expects that all of the required reforms will be carried out, and that in 2018 Ukraine will receive about USD 2 billion in IMF loans, as well as loans from the European Union and the World Bank. The aforesaid will ensure increase in the international reserves up to USD 20.7 billion.


However, in 2019–2020, the balance of payments is expected to run a deficit, and international reserves will stand at about USD 20 billion amid peak repayments on external public debt.


Accordingly, the main risk to the said macroeconomic forecast is that there may be no progress in implementing structural reforms that are required for maintaining macrofinancial stability and continuing cooperation with the IMF.


Any delays in taking the actions assigned in IMF-supported program reduce the likelihood that Ukraine will receive financing from the IMF. This narrows further the country’s opportunities to secure financing on the international capital markets required for making public debt repayments, which will peak in 2018-2020. Therefore, receiving less than the planned amount will make financing budgetary spending more difficult.


The following risks remain important:


continued capital outflow from developing economies, due to the central banks of advanced economies tightening their monetary policies faster than expected


a global economic downturn in the wake of large-scale trade wars


persistently high labor migration.


Is today’s monetary policy decision consistent with the central bank’s earlier decisions to keep the rate unchanged?


At the previous monetary policy meeting that took place in May 2018, the NBU Board said it could raise the key policy rate further if risks to lower inflation and macrofinancial stability increased.

As I have already pointed out, today the NBU feels the need to offset several factors that could put pressure on inflation in 2018 and 2019, and would pose a risk to meeting the 2019 inflation target but for this decision.


The NBU has also taken into account the rising probability that the outlined risks, including the risk that cooperation with the IMF does not resume, materialize.


In this light, the NBU Boards deems it necessary to tighten monetary policy by raising the key policy rate.


What will be the NBU’s monetary policy stance in future?


If there is good reason to believe that the above risks will increase further, or if new significant threats to lower inflation or macrofinancial stability appear, the NBU could raise the key policy rate again to a level required to bring inflation back to its target in the medium term.


A new detailed macroeconomic forecast will be published in the central bank’s Inflation Report on 19 July 2018.  


A summary of the discussion by Monetary Policy Committee members that preceded this decision will be available on 23 July 2018.


The next meeting of the NBU Board on monetary policy issues will be held on 6 September 2018.


Thank you for your attention!


Last modification   12.07.2018