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The National Bank of Ukraine Retains its Key Policy Rate Unchanged

The NBU Board has decided to maintain its key policy rate at 14% per annum. It is intended to mitigate the inflation risks hampering the achievement of inflation targets in 2017-2018.

Headline inflation considerably slowed down in 2016 to 12.4% from 43.3% in 2015, which was in line with the NBU forecast. Therefore, the NBU has met its inflation target set in the Monetary Policy Strategy for 2016-2020.

In 2016, fast disinflation was prompted primarily by effect of fundamental factors. This was evidenced by acute drop in core inflation (to 5.8% pp) against the backdrop of prudent monetary and fiscal policies. Stronger role of the key policy rate and its cautious decrease throughout the year, as well as the Government’s efforts aimed at keeping the fiscal deficit within the target range contributed to significant improvements in inflation expectations in the first three quarters of the year.

Besides, the inflation pressure was easing owing to high supply of raw foods, while the prices were pushed up mainly by increase in utility tariffs and recovery in global oil prices, which made domestic fuel prices edge up.

Further, the decline in inflation was facilitated by a moderate exchange rate volatility observed through most of the year owing to NBU measures aimed at smoothing excessive exchange rate fluctuations. However, despite favorable external and internal fundamental factors, in late December - early 2017, the depreciation pressure on the hryvnia gained in strength due to a number of situational factors. First, the foreign exchange market was impacted by a seasonal decline in business activity, in particular lower FX earnings from agricultural exports. Second, foreign currency supply was restricted due to high hryvnia liquidity held by exporters that received UAH 16 billion in VAT refunds in December 2016. Third, the FX demand rose following high budget expenditures in December.

The NBU is committed to achieve inflation targets of 2017-2018

The NBU expects inflation within the announced target band (8% ± 2 pp for 2017 and 6% ± 2 pp for 2018).

The disinflation trend will be ensured through prudent monetary and fiscal policy and much lower rates of administered tariff growth.

At the same time, inflation forecast for 2017 is revised from 8.0% to 9.1% primarily due to the minimal wage rise up to UAH 3,200 effective from the beginning of the year. The decision of the Government to increase minimal wages will have an effect on inflation directly through bolstered consumer demand (mainly for foods) and higher production costs, and indirectly through inflation expectations of Ukrainians.

Higher consumer demand and productions costs are projected to put additional pressure on the main inflation components in 2017, pushing core inflation up to 6.3%, and raw food inflation up to 7.0%.

Apart from that, year-on-year inflation is expected to remain high in the first three quarters due to statistical base effect. It will return to one-digit figures only in Q4 2017.

At the same time, the NBU does not consider reasonable to implement monetary policy instruments to reach inflation projections of 8.0% at the end of 2017 (central point of target range). It could lead to the undue volatility of market interest rates and inflation in the future and might slow down the economic growth that is currently at its recovery phase.

The NBU did not change its 2018 inflation projections of 6%.

The NBU has revised its 2017-2018 GDP growth projections.

GDP growth is expected to speed up, to 2.8% in 2017 and 3.0% in 2018, versus growth of 1.8% in 2016. This will gradually bring the economy to its potential GDP level over the forecast horizon. This means that although aggregate demand continues to rein in inflation, its impact will gradually become weaker versus previous years (and the previous forecast).

Stronger consumer demand driven by higher minimal wages is expected to foster economic growth in 2017. Exports are also projected to return to growth, due to terms of trade improving and last year’s good harvest. A rise in export earnings will make it possible for export-oriented enterprises to increase their investments at a relatively high pace. However, with still low rates of potential economic growth and slow import substitution processes, imported goods will be largely used to meet higher domestic investment demand.

Higher demand for imported goods was a key driver of the current account deficit widening to USD 3.4 billion in 2016 by our estimates. The impact of these factors is expected to continue in 2017-2018. Accordingly, the NBU revised the forecast for current account deficit to hover around USD 3.5 billion in these years. This deficit will be offset by financial account inflows, resulting mostly from investment and borrowing. As a result, the overall balance of payments is projected to record a surplus in 2017-2018.

Along with surplus of consolidated balance of payments, the disbursement of planned tranches under the program of cooperation between Ukraine and the IMF will increase the international reserves by the end of 2017 to USD 21.3 billion. Further accumulation of reserves remains an important task for the NBU and the Government, given high volumes of external payments under public debt starting with 2019.

Key risks for the baseline scenario imply the growth of geopolitical turbulence and its negative impact on the global economy and economy of Ukraine, as well as the risk of departure from the prudent fiscal policy, including raising social standards even more strikingly than the inflation targets justify it.

Moreover, the NBU hopes that the Government will be interested in achieving the inflation targets since the yield of new long-term hryvnia bonds to be issued as a result of re-profiling the domestic bonds from the NBU portfolio will be linked to inflation.

The furtherance of structural reforms necessary to preserve the macrofinancial stability, expansion of economy’s potential, and continuation of the EFF program with the IMF are also important.

In 2017, the NBU will proceed with the prudent monetary policy that will be aimed at decreasing the inflation to meet the inflation targets.

Given the increased concentration of inflation and FX risks recently, the NBU Board adopted the decision to preserve the key policy rate at 14%.

The decision to keep the key policy rate at 14% is approved by NBU Board Decision No. 49–D On the Key Policy Rate, dated 26 January 2017.

А new detailed macroeconomic forecast will be published in the Inflation Report on 2 February 2017.

The next meeting of the NBU Board on monetary policy issues will be held on 2 March 2017 as scheduled.

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