The Board of the National Bank of Ukraine has decided to cut the key policy rate to 15.5%, effective from 29 July 2016. Further alleviation of risks to price stability enabled the NBU to ease monetary policy, which is consistent with the need to achieve the NBU’s inflation objectives set at 12% +/-3% for 2016 and 8% +/-2% for 2017.
In June 2016, headline inflation slowed to 6.9% y-o-y. Actual inflation decelerated at a faster-than-projected pace.
Low aggregate demand, a gradual appreciation of the hryvnia exchange rate, and a high supply of food products have contributed to the slowdown in inflation.
Real wages resumed growth in annual terms. However, as before, consumer demand did not exert additional pressure on inflation.
With the external conditions remaining broadly favorable, a net foreign exchange supply was recorded in the domestic market. Under such circumstances, the NBU continued to purchase foreign currency to replenish its international reserves while not hampering a gradual appreciation of the exchange rate. As anticipated, the consequences of June’s relaxation of administrative restrictions appeared to be manageable and did not destabilize the FX market.
Also, a high supply of raw foods pushed food prices down in H1 2016.
Overall, these factors contributed to a faster-than expected slowdown in core inflation, having more than offset a contribution from administered prices and tariffs as well as oil prices.
The slowdown of actual inflation, along with the exchange rate appreciation, contributed to improvements in inflation expectations of households, businesses, and the expert community.
As previously projected, the medium-term inflation objectives remain unchanged at 12% by the end of 2016 and 8% by the end of 2017.
In H2 2016, annual headline inflation is expected to approach the target, mainly due to the reflection of upward adjustments in statistics for utility tariffs.
At the same time, inflation in respect of other consumer basket components (core inflation and raw food prices) is expected to slow at a faster pace. The faster-than-expected deceleration can be attributed to the slowdown in imported inflation in the wake of low exchange rate volatility and improved inflation expectations.
The NBU has also maintained its annual real GDP growth forecast unchanged at 1.1% by the end of 2016 and 3.0% by the end of 2017. However, we revised the current account deficit forecast downwards from USD 2.3 billion to USD 1.8 billion. The downward revision reflects lower natural gas imports, improvements in the terms of trade, a projected high yield of crops, and larger private remittances from abroad.
Headline inflation might come in below the 2016 year-end inflation objective of 12% should assumptions other than those reflected in the baseline forecast scenario materialize. These assumptions include more significant effects of subdued consumer demand, the oversupply in the domestic market resulting from a high yield of crops, and favorable external conditions.
In the medium-term perspective, the resumption of cooperation with the IMF, absence of adverse shocks in external markets, de-escalation of hostilities in the east of Ukraine, and, as a consequence, further improvements in inflation expectations remain the key factors supporting disinflation.
Should the baseline forecast scenario materialize and risks to price stability abate further, the NBU will continue to move ahead with monetary easing. This move will promote the reduction of borrowing costs and boost economic growth.
The decision to cut the key policy rate to 15.5% is approved by NBU Board Decision No. 172-рш, dated 28 July 2016, On the Key Policy Rate.
A detailed macroeconomic forecast will be published in the Inflation Report on 4 August 2016.
The next meeting of the NBU Board on monetary policy issues will be held as scheduled on 15 September 2016.