The Board of the National Bank of Ukraine has decided to cut the key policy rate to 18%, effective 27 May 2016. The move was made possible due to a steady disinflation trend, which is consistent with the inflation objectives for 2016 and 2017.
In April 2016, as expected, twelve-month headline inflation slowed to single-digits for the first time in two years, reaching 9.8% y-o-y. However, in monthly terms, inflation was higher than in the previous months, standing at 3.5% m-o-m. The increase in monthly inflation reflected the elimination of preferential natural gas tariffs for households, effective through 31 March 2016. Yet, headline inflation posted only a 5.1% year-to-date increase.
The downward trend in core inflation in April 2016 was in line with the NBU's expectations,, reflecting weakening fundamental factors such as lower inflation pressures.
Disinflation was underpinned by subdued domestic consumer demand, tight monetary policy, and appreciation of the hryvnia exchange rate observed in recent months.
In Q1 2016, real GDP posted a modest increase in annual terms (0.1%), reflecting weaker recovery in domestic demand. Annual GDP growth was slower than projected.
Consumer demand remained subdued, reflecting weaker real wage growth. In March, real wages posted an annualized increase of 1.6% for the first time in two years. However, overall in Q1 2016, real wage growth was 6.8% lower than in the same period a year ago. Although businesses benefited from additional financial resourses released as a result of lower allocations to social funds, the increase in real wages was moderate and insufficient to trigger inflation pressures.
Disinflation was supported by a gradual appreciation of the hryvnia exchange rate, which was underpinned by improved external conditions, and, as a consequence, higher foreign exchange receipts from exports. These developments enabled the NBU, which remained firmly committed to a flexible exchange rate, to purchase foreign currency to replenish its international reserves, while not hampering a gradual appreciation of the exchange rate triggered by fundamental factors.
The NBU believes that the 2016 and 2017 end-year inflation targets set at 12% +/-3% and 8% +/-2%, respectively, remain within reach.
Given the upward adjustment of tariffs for heating and hot water recently announced by the government, administered prices are expected to be a major contributor to the Consumer Price Index in 2016. However, in 2017, their contribution to the CPI is likely to be less significant than projected in the Inflation Report (April 2016).
Increases in administered prices and tariffs accounted for temporary surges in inflation in some months of 2016. However, their further adjustment to cost-recovery levels (market levels) will not require the NBU to pursue a tighter monetary policy. First, in the medium-term, this move will contribute to keeping inflation on a downward path through the elimination of distortions in price-setting mechanisms in the periods ahead. Second, this adjustment will help contain pressures on inflation from households’ effective demand for other goods and services as early as in 2016.
Accordingly, due to this and other factors, the upward pressure on headline inflation from domestic demand-side factors is expected to be insignificant over the forecast horizon. Instead, economic recovery will be driven by investments and supported by external demand.
The continuation of cooperation with the IMF is critical for achieving price stability. Accordingly, the Government's resolve to move urgent reforms forward and the support of parliament is essential to keeping the program on track.
Should risks to price stability abate further, the NBU will move ahead with monetary easing to support the economic recovery.
The decision to cut the key policy rate to 18% is approved by NBU Board Decision No. 25-psh, dated 26 May 2016, On Money Market Regulation.
The next meeting of the NBU Board on monetary policy issues will be held as scheduled on 23 June 2016.