In 2017, headline inflation reached 13.7% yoy, according to the State Statistics Service of Ukraine, exceeding the National Bank of Ukraine’s target of 8% ± 2 pp for the end of the year set in the Monetary Policy Guidelines for 2017 and Medium Term.
The year-end inflation has deviated from the target mainly due to factors beyond the National Bank’s control through monetary policy tools. This primarily refers to a reduction in the supply of some products caused by unfavorable weather conditions in the first half of the year, unstable situation in animal breeding, and rising global prices and external demand for domestic food products (particularly, meat and dairy products). Higher production costs, especially labor costs, and a fast recovery of consumer demand also contributed to price increases.
- Сore inflation accelerated to 9.5% yoy in 2017, from 5.8% yoy in 2016. Prices for services included in core inflation increased markedly driven by rising production costs and a buoyant consumer demand, among other things, due to the increase in the minimum wage and pensions. In particular, growth in prices for fast food, higher education, and maintenance and repair of dwellings had the largest impact on inflation.
Prices for processed foods, especially dairy and meat products, also grew at a faster pace due to more expensive raw materials as well as large export volumes of some food products (particularly, butter).
At the same time, growth in non-food prices slowed down to 3.3% from 4.8%last year. With most of these non-food goods (clothing and footwear, home appliances, etc.) being imported, the slowdown in the price growth has been driven by benign foreign exchange markets throughout most of the year and moderate inflation in trading partner countries.
- Growth of raw food prices accelerated substantially in 2017 compared to the previous year – to 23.5% yoy – and were the main contributor to headline inflation. In particular, prices for meat and raw milk grew at a fast pace and egg prices resumed growth. These developments were a reflection of considerably higher global prices for these goods and a pickup in exports, as well as a limited domestic supply amid decreasing livestock (except poultry) and unstable epizootic situation.
Moreover, after a drop in 2016, prices for fruit and vegetables soared last year, which was due to several reasons. First, unfavorable weather in the first half of the year affected supply of some fruit and vegetables and, consequently, their prices. For example, prices for berries and apples, as well as for somevegetables (carrot and beetroot), grew almost 1.5 times. Second, some price correction in the domestic market was expected, as the effect of supply factors that curbedfruit and vegetables in 2016 had waned. In particular, as Russia lifted the ban on imports, supplies of Turkish food products to Russia increased at the expense of supplies to Ukraine.
On the other hand, sugar prices continued to decline amid low global prices and ample supply in the domestic market. A good harvest has driven buckwheat prices down.
- Growth of administered prices expectedly decelerated to 16.1% yoy as utility prices did not increase as much as in 2016. At the same time, in 2017, prices for tobacco products, postal and transportation services accelerated on the back of higher costs.
- In 2017, fuel prices grew at a fast pace (20.0% yoy), roughly in line with the previous year, due to higher oil prices and the depreciation of the hryvnia against the euro (fuel excise taxes are set in euro).
In October, during the last revision of macroeconomic indicators, the NBU announced that year-end inflation would deviate from the target range, however the deviation turned out greater than expected. This was driven by a number of factors that occurred at the end of the year. In particular, condition in the foreign exchange market deteriorated, fiscal policy was loosened more significantly, with higher pension payments as one of the reasons. This has led to an increase in the underlying inflationary pressure, which was reflected in the core inflation measure.
Deviation of actual inflation from central bank targets are unavoidable under inflation targeting regime.
Inflation targeters often face the situation when inflation deviates from the target due to reasons beyond their control. For example, inflation in Israel has been deviating from the target for 74% of the time since 2000, in Poland it has been deviating for 73% of the time since 2001, and for 65% of the time in Czech Republic.
In cases like this, central banks must take measures to bring inflation back to the target within a certain timeframe. The appropriate response and communications help avoid deterioration of expectations and reduce uncertainty about future inflation. The time for inflation to return to the target depends on the type and the magnitude of shocks, whether inflation expectations are anchored to the target level, effectiveness of monetary tools, and other factors.
The NBU acts in line with international inflation targeting practices: in the summer, the regulator stopped easing its monetary policy, as inflation risks intensified, and moved to policy tightening in October. The NBU Board raised the key policy rate twice in Q4 (by 2 pp in total, to 14.5%) in order to gradually bring inflation down to the target over the medium term.
The tight monetary policy will push inflation down over time. Changes in the key policy rate effectively transmit into other interest rates – first, money market rates and then commercial bank lending and deposit rates. In turn, a rise in commercial bank rates should encourage inflow of savings into the banking sector and, therefore, restrain consumer demand. Higher rates will make financial instruments in domestic currency more attractive compared to their foreign currency counterparts, which will have a positive impact on inflation in future through the exchange rate channel. In addition, tight monetary policy will prevent inflation expectations from deteriorating further.
The NBU will continue to focus on price growth deceleration and meeting the inflation targets. As before, the central bank will balance the need to reduce inflation against the need to minimize adverse short-term consequences for growth and a resumption in bank lending.
The NBU will reveal the trajectory and timelines for inflation to return to the target in its new macroeconomic forecast, which will be made public on 25 January 2018 during the press briefing on decisions taken by the Board at the monetary policy meeting. More details of the forecast will be given in the Inflation Report to be published on 1 February 2018.