The Board of the National Bank of Ukraine has decided to hike its key policy rate to 14.5% per annum, effective from 15 December 2017. In light of heightened inflation risks, the tightening of monetary policy is necessary to bring inflation down to its target in the mid-term.
Over the past two months headline inflation rates were declining, although at a slower pace than the NBU has projected. In November 2017, headline inflation stood at 13.6%. The deviation of inflation from its target has been driven by faster than expected rates of core inflation due to higher production costs and buyoant consumer demand, as well as higher than expected growth rates of prices for raw foods and fuels.
Headline inflation slowed down mostly due to exhaustion of the factors which were drivers behind a steep mid-year increase in prices for raw foods in the middle of the year, namely, of milk, meat and vegetables.
Prices of highly processed foods went up much higher than expected due to increased prices for respective raw foods in previous months. Moreover, prices for services were increasing at a faster pace driven by rising production costs and buoyant consumer demand.
Against this background, core inflation accelerated to 8.6% reflecting the strengthening of underlying pressure on consumer prices.
Fuel prices also grew bolstered by higher global oil prices and depreciation of the hryvnia against the euro (as fuel excise taxes are set in euro).
Less than prompt decline in inflation shows a more significant deviation of inflation from its target by the end of 2017 than has been earlier projected.
Moreover, since the previous decision on key policy rate and the publication of the recent NBU’s macroeconomic forecast, risks that may restrain a decline in inflation next year have become more likely to materialize.
These are in particular:
State budget spending in 2018 is planned at a significantly higher level than that on which the NBU’s October forecast has been based. Social standards may also be raised further, which may propel both household consumer demand and costs of products and services.
Risks of postponing the disbursement of the next IMF tranche under the EFF program have increased.
Growing raw food prices may further exert a significant impact on highly processed food prices, as was the case in the second half of 2017.
The global economic growth may prove more significant than previously estimated, which may stimulate labor migration that may further translate into growing wages.
These factors have contributed to the deterioration of inflation expectations, mainly of businesses and households, in recent months.
When making its key rate decision in October 2017, the NBU Board said that it might raise the key policy rate further if these risks materialized.
In view if the need to offset the influence of these risks and to bring the inflation rate back to the target, the NBU has decided to hike the key policy rate to 14.5% per annum.
The NBU Board is convinced that achieving price stability is a precondition for sustainable economic growth. In particular, a sustained improvement in inflation expectations is the main factor of an interest rate cut in the mid-term.
If fundamental inflation risks increase further, the NBU may resort to further key rate hikes to bring inflation back to the target range. The next key rate decision, which will be taken in January 2018, will factor in new macroeconomic projections, inflation projections in particular.
The decision to raise the key policy rate to 14.5% has been approved by NBU Board Key Policy rate Decision No. 793-D, dated 14 December 2017.
The next meeting of the NBU Board on monetary policy issues will be held on 25 January 2018 as scheduled.