Dear colleagues,
I’d like to greet all the participants in this follow-up meeting on the NBU Board’s monetary decision.
I would like to inform you that the NBU Board has decided to hike its key policy rate to 13.5% per annum, effective 27 October 2017. A tighter monetary policy will contribute to lowering headline inflation and bringing it closer to the target next year.
Let’s have a look at inflation tendencies since the Board's last monetary policy meeting.
In September 2017, headline inflation accelerated to 16.4% yoy, which exceeded the NBU forecast published in the July Inflation Report. This was primarily driven by a quicker growth in raw food prices, higher production costs, and a revival of consumer demand.
Same as previous months, supply factors contributed to the fast pace of rising domestic prices for fruit and vegetables, meat and dairy products.
By influencing the cost of highly processed foods, the growth in raw food prices had an indirect impact on core inflation, which also exceeded expectations.
In addition, higher service prices also contributed to a rise in core inflation as a result of cost increases, including labor costs.
An anticipated pickup in consumer demand also contributed to the core inflation acceleration (7.7%). As the private sector raised wages on the back of high demand for labor, household incomes increased, while social initiatives led to a gradual improvement of consumer confidence.
However, households still tapped their savings to maintain consumption levels. Moreover, slow growth in other nominal household income (primarily from business and property) continued to restrain consumer demand.
Rather tight fiscal and monetary policies curbed core inflation.
The FX market also put no pressure on the inflation levels.
In general, the fundamental factors remained in force, having contributed to the hryvnia strengthening against the US dollar during most of the year.
In particular, today global prices for Ukrainian steel are 56% higher and iron ore prices 7% higher than a year ago. As a result, metal companies continue to sell large amounts of FX revenues, exceeding the last year’s levels.
Prices for certain grain crops grew as well. For example, wheat prices are 14% higher than a year ago.
Investors who transfer funds to Ukraine in order to invest into UAH domestic government bonds and privatization agreements gradually increase the supply of foreign currency.
The September–October weakening of the exchange rate was mostly driven by situational factors and the impact that previous years’ seasonality had on economic agents.
First, the period of intensive harvesting coincided with an increase in global oil prices, which made oil traders buy more foreign currency.
Second, as compared with the summer, Ukrainian companies bought more foreign currency to repay and service loans taken from nonresidents and FX loans owed to Ukrainian banks. This also complies with annual business activity peaks.
Third, influenced by physiological factors, households raised the demand on the cash FX market.
At the same time, supply of foreign currency was limited as revenues of agricultural companies from the new harvest did not fully start to feed the FX market.
The NBU smoothened excessive fluctuations of the hryvnia exchange rate – since September, the net amount of foreign currency sold by the NBU through interventions has made USD 227 million.
After a lasting trend for improvement, inflation expectations deteriorated over the recent months. Based on surveys conducted among households, banks, and financial analysts in September-October, the NBU reports an increase in the expected price growth rates for the following 12 months. The deterioration of expectations is driven by the current high growth rates of prices and the announced substantial increase in social standards.
What is our inflation forecast for the future?
Inflation will decelerate and approach its target levels. However, this process will be slower than forecasted earlier, which is taken into account in the revised inflation forecasts for the current and following years.
The NBU has revised the inflation forecast as inflation accelerated over the recent months and new inflation factors appeared. In particular, a stronger pickup in consumer demand, a rapid growth in pension payments, the minimum wage, excise taxes on tobacco products, etc.
We expect that before the end of the year, inflation will slow down to 12.2%.
Next year, it will continue to slow down and will come close to the central point of the target range, 6.5% +/- 2 pp in Q3 2018. By the end of next year, inflation is projected to reach 7.3%.
Inflation projections for 2019, at 5.0%, have remained unchanged.
Inflation is expected to decelerate in 2018 - 2019, due to the NBU conducting a relatively tight monetary policy, the effect of a sharp consumer price rise fading away, and the exchange rate being only moderately volatile.
Both raw food inflation and core inflation, which significantly depends on the former, will slow down. Overall, fundamental inflation pressure will be modest on the forecast horizon.
The largest increase in inflation components in 2018 - 2019 will be in administrated prices, which are expected to rise by over 10% a year. This will be mainly due to the expected gradual growth in global energy prices, which will pass through to domestic prices, and the government policy to harmonize the Ukrainian tobacco excise taxes with the EU rate.
The NBU has revised its 2017-2019 real GDP growth projections
The NBU has revised its 2017 economic forecast upward (from 1.6% to 2.2%). This was the result of a more favorable than expected effect from both internal and external factors on the economic performance of most sectors in Q2 and Q3 of the current year. In particular, private consumption picked up, driven by faster growth in real wages, while businesses’ investment remained high. External conditions continued to be favorable for both Ukrainian export prices and demand for Ukrainian goods.
At the same time, a decline in the output of some industrial sectors, resulting from limited access to the goods produced by the companies located in the non-government controlled areas, was a drag on economic growth.
GDP growth is expected to speed up to 3.2% and 3.5% in 2018 and 2019 respectively.
Private consumption will continue to be the main driver of economic growth in these years, thanks to higher wages and pensions, better consumer sentiment, and a pick-up in consumer lending.
As before, agricultural, mining, metallurgical and construction companies will make large investments.
Imports will rise further, driven by a pick-up in consumer demand, higher investment and an increased need for imported energy carriers.
Exports will also grow, due to, among other things, the expected return of metallurgical companies to their previous production levels as these companies find new energy sources to replace the ones located in the non-government controlled area. Export growth will also result from favorable external conditions and high food industry output.
In this light, the current account deficit will continue to hover around USD 4 billion in 2017 - 2019. It will be fully offset by financial account inflows.
A key assumption of this forecast is that Ukraine will continue to cooperate with the IMF.
An overall balance of payments surplus, together with other tranches received under the EFF, will push up international reserves further.
The NBU expects that the next EFF tranche will be received in Q1 2018. Together with a surplus of the overall balance of payments, this is expected to drive international reserves up to USD 22.2 billion by late-2018.
The NBU, however, sees several risks to this forecast.
The temporary supply factors that drove up raw food prices this year and caused consumption to pick up further amid higher social standards could increase fundamental pressure on inflation.
In addition, the Ukrainian economy could become more vulnerable if external official financing under the EFF is delayed.
With the aim of bringing inflation to the inflation targets and taking into account the above risks the NBU deems it necessary to hike the key policy rate, up to 13.5% per annum.
Tighter monetary policy is primarily aimed at preventing inflation expectations from further deterioration.
Moreover, tighter monetary stance is a response to higher risks of delays in resumption of cooperation with the IMF and faster expansion of consumer demand owing to rising social standards.
Tighter monetary policy will help curb inflation through several channels. A rise in key police rate will facilitate an inflow of savings into the banking sector and, therefore, restrain consumer demand. Also, higher interest rates make financial instruments in domestic currency more attractive than those in foreign currency, which will have a positive effect on inflation via the exchange rate channel.
The tight monetary policy will bring inflation close to the central point of the target range in Q3 2018.
The NBU Board is confident that the achievement of price stability is key to sustainable economic growth. In particular, steady improvement of inflation expectations is a major factor in reducing banks' interest rates in the medium term.
What kind of monetary policy is expected in the future?
In the event of realization of the above inflation risks, the NBU may further raise the key policy rate to offset their effects and return inflation to its target path.
However, in case of deceleration of inflation according to the forecast, further cooperation with the IMF, and pursuing prudent fiscal policy, the NBU may return to easing the cycle of monetary policy easing at the end of 2018.
To learn more about a new macroeconomic forecast, please see the Inflation Report that will be published on 2 November 2017.
Let me remind you that the next meeting of the NBU Board on monetary policy issues will be held on 14 December 2017.
Thank you for your attention!