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National Bank of Ukraine Cuts the Key Policy Rate to 13%

The Board of the National Bank of Ukraine has decided to cut the key policy rate to 13%, effective 14 April 2017. The resumed cycle of the monetary policy easing is in accord with the pursuit of inflation targets set for 2017-2019 and will help propel the economic growth in Ukraine.

In March 2017, headline inflation was recorded at 15.1% yoy. Price growth has accelerated primarily due to base effects and higher production costs.

Actual acceleration of headline inflation was as expected, although at a lower trajectory than projected in the NBU’s Inflation Report in January 2017. The NBU then projected inflation in March to accelerate to 16.4%.

The fundamental factors that determine inflation have remained under control. Prudent fiscal and monetary policies against a backdrop of improved inflation expectations restrained acceleration of core inflation (in March 2017, 6.3% in annual terms).

Demand-pull pressure on prices has remained moderate, as evidenced by the anemic growth in retail goods turnover in the first months of the year. The revival of economic activity and the improvement in business outlook of enterprises contributed favorably to the recovery of labor demand. However, unemployment remains at a high level due to labor market mismatches.

The situation in the FX market has helped weaken pressure on prices. The external price environment for Ukrainian exporters has become more favorable since early 2017 due to recovery in prices for steel, iron ore, and grains, with an export potential being further bolstered by record high grain and oil crop yields. Appreciation of the hryvnia since mid-January was underpinned by solid export revenues.

Inflation is projected to decrease to target levels in 2017 – 2019

The NBU forecasts that inflation in 2017 – 2019 will meet the announced targets (8% ± 2 pp for 2017, 6% ± 2 pp in 2018 and 5% ± 1 pp in 2019). The NBU inflation forecast for 2017 remains at a level of 9.1% and 6.0% in 2018. Headline inflation is projected to decrease to 5.0% in 2019.

Throughout Q2 and Q3 of 2017 inflation in annual terms is forecasted to remain in the double-digit range and volatile. It is attributed to the base effects, namely the administered price dynamics in 2016. Inflation will only return to a one-digit range in Q4 2017.

No significant deviations of core inflation from the current level (6.5%) are projected by the end of the year. Recovery of consumer demand and second-round effects from the higher food price inflation will be the inflation driving factors.

Prices for unprocessed foods will rise at a faster pace in the following months driven by a number of factors. First, global food prices are projected to move on an upward trajectory. Second, opening of the new markets will result in a lower supply of certain types of domestically produced foods in Ukraine.

In addition to supply factors, there is also an effect of demand factors. Consumer demand is expected to recover gradually due to a fast-growing nominal household income.

The halt on transferring cargo across the line of contact in the eastern Ukraine will have no significant impact on the headline inflation.

In 2017 – 2019, prudent monetary and fiscal policies supporting controlled rise in consumer demand and moderate FX rate volatility will be the key drivers of the disinflation process. Growing investments in agriculture will improve its performance that is still lagging behind leading countries. This will curb the food price inflation in the mid-term.

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

Economic growth is projected to slow to 1.9% in 2017. This downward revision resulted from expectations that the hold on trade in eastern Ukraine and the loss of the production facilities located in the rebel-controlled areas will decrease the output of some industries. These are the metallurgical and mining industries, coke production, and the electrical industry. This negative influence will be partly offset by a more favorable external environment.

Real GDP growth is forecasted to increase to 3.2% in 2018 and 4.0% in 2019. The economy will be driven by reasonably high growth in consumer and investment demand. This demand will stimulate growth in imports of goods and services. However, it will be partly offset by a gradual increase in the country’s export potential in 2018 and 2019.

The balance of payments projections have been revised in response to the blocade on trade and a revision of the terms of trade

The projections for a 2017 current account deficit have been increased from USD 3.5 billion to USD 4.3 billion or 4.4% of GDP. The trade blocade is expected to decrease the export potential of the metallurgical industry, while increasing the need for imported raw materials. However, this will be partly offset by a rise in global commodity prices.

The 2018-2019 current account deficit, although remaining unchanged in nominal terms (USD 4.3 billion), will gradually narrow to 4.1% of GDP in 2018 and 3.7% of GDP in 2019. This will be attributed to a rise in the economy's export potential, due to investment picking up.

The 2017-2019 current account deficit will be counterbalanced by net financial account inflows. In particular, in 2017, debt inflows to the private sector will resume, while households’ demand for foreign currency cash will continue to fall. In 2018, an improved business climate and faster economic growth are projected to increase debt inflows and foreign direct investment in the private sector.

Surplus of the overall balance of payments, together with the planned tranches received under the IMF EFF and other related financing programs, will enable the NBU to accumulate further the international reserves. At the same time, replenishment of reserves through FX purchases in the interbank market will be less intensive than expected earlier due to the negative effects of the blocade with certain areas of Donetsk and Luhansk oblasts on the external trades.

Therefore, the international reserves are estimated as USD 21.1 billion as of the end of 2017 and USD 26.2 billion as of the end of 2018.

The major risk for the above scenario can be a failure by the private sector and the Government to efficiently minimize losses from the seized transfer of cargo across the contact line in the ATO area. Apart from that, we still face a high risk of escalation of the military conflict in eastern Ukraine.

A negative impact may be experienced due to departure from the prudent fiscal policy, including raising social standards even more strikingly than the inflation targets justify it. The furtherance of structural reforms necessary to preserve the macrofinancial stability, especially of those specified as Ukraine’s commitments under the EFF program with the IMF, is also important.

Overall, according to the NBU Board, the inflation forecast and the balance between risks is appropriate for for further monetary policy easing. 

Therefore, the NBU Board has decided to cut the key policy rate to 13%.

Further monetary policy easing depends on mitigation of risks to price stability on the forecast horizon.

The decision to cut the key policy rate to 13% is approved by NBU Board Decision On the Key Policy Rate No. 232-рш, dated 13 April 2017. 

А new detailed macroeconomic forecast will be published in the Inflation Report on 20 April 2017.

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

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