12 July 2018
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.
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, and 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.
June 2018 saw a substantial
slowdown in consumer price inflation that reached 9.9% yoy,
which was somewhat below the NBU’s forecast published
in the April 2018 Inflation Report. 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. In addition, a
strengthening in the hryvnia exchange rate, which was driven in particular by
the tightening of monetary policy by the NBU, had a favorable effect on 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 sustained growth in consumer demand, which is
fueled by a rapid rise in incomes that substantially outpaces the rates of
The impact of
inflation factors will become stronger in future, but the tight monetary policy
will offset their effect and drive inflation back to the target range in 2019.
The NBU keeps its
inflation forecast for year-end 2018 unchanged at 8.9%. 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, and the subsequent rise in utility services prices.
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:
domestic demand, which is, among other things, due to wage growth and greater
remittances from labor migrants
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
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
conditions, the tighter monetary policy will be among the key factors to drive
inflation down along the forecast path and bring it to the target range in
Q4 2019. Therefore, the NBU makes no change to its inflation forecast for
year-end 2019, that is 5.8%.
In 2020, inflation
will decelerate to 5.0%, the mid-point of the target range (5.0% ± 1 pp).
After speeding up in
2018, economic growth will slightly decelerate.
The NBU believes that
the forecast of 2018 real GDP growth of 3.4% is still relevant. Economic growth
will continue to be mainly driven by private consumption, which in the current
year will be fueled by the persisting high rate of growth in real wages on the
back of high migration. 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 net exports to GDP.
In 2019, real GDP
growth will slow to 2.5% (2.9% in the previous forecast), due to the waning
effects of higher social standards, the tight monetary conditions required to
bring inflation back to its target, as well as tight fiscal policy resulting
from the need to repay large volumes of public debt.
In 2020, the real
economy is expected to grow by 2.9%.
Private consumption, additionally supported by rising remittances thanks
to an increase in the number of labor migrants, will remain the main driver of
economic growth in the medium-term. Meanwhile, investment growth will be
restrained by businesses’ higher labor costs. However, the contribution of net
exports will remain negative over the forecast horizon, as imports will satisfy
a significant portion of domestic 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
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
by the end of this year. 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, which is required for maintaining macrofinancial stability and continuing cooperation with
Any delays in taking
the actions assigned in IMF-supported
program reduce the likelihood that Ukraine will receive financing from
the IMF, and narrow 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
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.
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. In this light, in view
of the need to offset the outlined factors that could put pressure on inflation
in 2018 and 2019, and taking into account the higher probability that the
outlined risks could materialize, the NBU Boards deems it necessary to tighten
monetary policy by raising the key policy rate.
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 over the forecast horizon.
The decision to raise the key policy rate to 17.5% has been approved by
NBU Board Key Policy Rate Decision No. 443-D, dated 12 July 2018.
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 published on 23 July 2018.
The next meeting of the NBU Board on monetary policy issues will be held
on 6 September 2018 as scheduled.