The Board of the National Bank of Ukraine has decided to cut the key policy rate to 16.5%, effective 24 June 2016. Further easing of monetary policy fully complies with inflation target for 2016 and 2017 and takes place under conditions of steady inflationary pressure reduction, improved inflation expectations and stable foreign exchange market situation.
In May 2016, headline inflation dropped to 7.5% y-o-y, which was consistent with the NBU’s projections.
Inflationary pressure reduction was of a fundamental nature confirming core inflation slowdown. That was favored by prudent monetary policy and strengthening of hryvnia exchange rate due to favorable world commodity markets situation. In addition, increase of foods supply supported the disinflationary trend.
Domestic demand remains moderate and does not put additional pressure on prices. Thus, in Q1 while recovery of the economic growth y-o-y, as expected, households consumption still remained lower than in the previous year (by 2.2%). According to the NBU estimates, economic growth accelerated in Q2 due to external and investment demand. That was favored by improved global commodities markets situation and better enterprise expectations against the background of internal political stabilization and agreement with the International Monetary Fund at expert level regarding second review of Extended Fund Facility Arrangement.
Favorable foreign economic conditions resulted in increased export earnings and improved foreign exchange market situation. Under these conditions, the NBU using a flexible exchange rate purchased foreign currency to replenish international reserves leaving an opportunity for moderate exchange rate strengthening caused by fundamental factors. In addition, normalization of foreign exchange market situation allowed the NBU to proceed with gradual liberalization of administrative limits.
Gradual exchange rate strengthening along with sustained inflation slowdown caused significant decrease in inflation expectations of households and business increasing control over prices in future.
Therefore, the NBU considers headline inflation targets at level of 12%+/-3 p.p. to be attainable by the end of 2016 and 8%+/-2 p.p. by the end of 2017.
In the second half of this year, the NBU expects inflation to get closer to target level y-o-y due to reflection of higher tariffs for public utilities in statistics. That was already provided by the NBU projections and will not require monetary policy responses.
As before, domestic demand pressure on headline inflation is expected to be insignificant. Improved prospects for grain and other agricultural crops due to favorable weather conditions are among factors supporting moderate price dynamics.
Global commodities markets situation will influence the foreign exchange market. Dividend repatriation, which started on 13 June 2016, will not have significant destabilizing influence, as under provided scheduled payments the supply on the foreign exchange market will be sufficient to meet these needs, according to the NBU estimates.
Completion of the second programme review under the Extended Arrangement remains a key factor for achievement of price stability over the medium term. Thus, government commitment to continue current reforms and their support of the Verkhovna Rada are important.
The NBU will proceed with monetary policy easing to support the recovery of economic activity when it is not in conflict with achievement of inflation targets. Gradual and moderate easing of monetary conditions will be an economy incentive and, at the same time, it will secure inflation from domestic demand pressure. Lower interest rates will raise demand for loans.
The decision to cut the key policy rate to 16.5% is approved by NBU Board Decision No. 88-рш, dated 23 June 2016, On Key Policy Rate.
The next meeting of the NBU Board on monetary policy issues will be held as scheduled on 28 July 2016.