The Board of the National Bank of Ukraine has decided to keep its key policy rate at 18.0% per annum. The current and forecast monetary conditions are sufficiently tight to bring inflation to its medium-term target of 5% in 2020.
In September 2018, consumer price inflation reached 8.9% yoy, having exceeded both the upper limit of the target range (6.5% ± 2 pp set for the end of Q3 2018) and the July projections of the NBU (8.3%).
The moderate drop in inflation compared with previous months was due to slower growth in food prices, driven by an increase in domestic and imported supply of food products, as well as lower global food prices.
At the same time, the underlying inflationary pressure remains strong. This is reflected in the sustained high reading of core inflation (8.7% yoy in September), which is above the NBU’s July projections. In particular:
- Domestic demand remaining high and further growth in production costs, including labor costs, put an upward pressure on prices.
- The hryvnia weakening against the US dollar in July–August influenced prices of some goods, especially imported ones.
- The rapid growth in global crude oil prices seen in the past months passed through to fuel prices and contributed to higher cost of other goods and services.
The above factors and the approaching presidential and parliamentary elections to take place next year affected the inflation expectations. In particular, expectations of households deteriorated. Businesses, banks, and financial analysts maintain high inflation expectations, at levels much above the NBU’s inflation targets.
Inflation will decline, although it will take longer than expected to meet the target
Having considered the above factors and the anticipated rise in administered prices, the NBU has revised its 2018 inflation forecast upwards, from 8.9% to 10.1%.
The increase in consumer demand, robust wage growth, and the recent jump of crude oil prices will continue to impact consumer price inflation next year. This will keep inflation above the target range for longer than expected. Inflation is projected to decline to 6.3% as of the end of 2019. It will enter the target range in Q1 2020 and reach the medium-term target of 5.0% at the end of 2020.
The slowdown in inflation will be mostly driven by the tight monetary conditions, which the NBU Board believes have formed as a result of the previous key policy rate hikes. Such conditions will ensure the balance between the need to reduce inflation and bring it to the target and the need to maintain the economic growth.
At the same time, other factors will enhance the tight monetary policy stance. Banks are expected to continue raising interest rates on hryvnia deposits of households due to shrinking bank liquidity surplus and in response to the previous key policy rate hikes. This will incentivize Ukrainians to shift from spending towards more saving.
Moreover, next year, labor migration from Ukraine will not put such a significant upward pressure on wages as in the previous two years.
Price rises will also be contained by prudent fiscal policy and the moderate pace of imported inflation on the back of reasonably low exchange rate volatility.
Among other things, exchange rate and inflation expectations are expected to benefit from positive signs that some progress has been achieved in ensuring cooperation with official lenders, in particular entering into a new arrangement with the IMF that will carry over for the next year.
After speeding up in 2018, economic growth will slightly decelerate.
The NBU has made no change to its economic growth projections for 2018–2020. As before, the central bank expects that economic growth will accelerate to 3.4% in the current year. The growth will be mainly propped up by private consumption, as household income increases further. The investment activity of companies will also remain rather buoyant.
In 2019, real GDP growth will decelerate to 2.5%, due to a slowdown in the global economy, a fall in global commodity prices, tight fiscal policy resulting from the need to repay large volumes of public debt, as well as tight monetary conditions required to bring inflation back to its target.
In 2020, economic growth will speed up to 2.9%. The growth will be fueled by a mostly gradual easing in monetary policy, which will become possible after inflation stabilizes at a level close to the target, as well as by the economy’s greater investment attractiveness.
External accounts will be in equilibrium in 2019 – 2020. The current account deficit will continue to hover between 2.5% and 3% of GDP, and will be offset by official financing and private capital inflows.
The NBU’s macroeconomic forecast is based on the assumption that Ukraine will continue to cooperate with the International Monetary Fund under a new Stand-By Arrangement.
The new Stand-By Arrangement can definitely be regarded as a positive development for Ukraine. First, new loans from the IMF, and related financing from other Ukrainian partners, will boost the country’s macrofinancial stability. Second, the new arrangement is an anchor for state policy, and will therefore lay the foundation for an improvement in expectations and Ukraine’s access to the global capital markets.
The NBU sees a further deterioration in inflation expectations and external conditions as the main risks that the said macroeconomic forecast may not materialize, including that inflation may not meet its 2020 target.
First, inflation expectations could continue to rise, driven by a new political cycle.
Second, external conditions could deteriorate. In particular:
- a more rapid slowdown in the global economy, including in the economies of Ukraine’s main trading partners
- decline in global commodity prices
- further energy price rise in the global markets
- capital outflow from developing economies, including Ukraine, due to the central banks of leading countries tightening their monetary policies at a fast clip.
Taking into account an updated macroeconomic forecast and the assessments of the above risks, the NBU Board believes that existing monetary conditions are tight enough to reduce inflation in the mid-term. In this light, the NBU Board has decided to keep its key policy rate at 18.0% per annum.
However, the NBU will continue to keep a close watch on factors of underlying inflationary pressures, in particular on consumer demand, inflation expectations and any progress achieved in ensuring cooperation with international official lenders.
If inflation pressures do not ease or build up, the central bank could raise the key policy rate again.
The decision to keep the key policy rate at 18.0% has been approved by NBU Board Policy Rate Decision No.714-D, dated 25 October 2018.
A new detailed macroeconomic forecast will be published in the central bank’s Inflation Report on 1 November 2018.
A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 5 November 2018.
The next meeting of the NBU Board on monetary policy issues will be held on 13 December 2018 as scheduled.