Dear colleagues!
I’d like to greet all the participants at our traditional meeting following the Board meeting on monetary issues.
I would like to inform you that the NBU Board moves ahead with monetary policy easing and has decided today to cut the key policy rate to 14%.
The decision to ease monetary policy further was made possible due to a further alleviation of risks to price stability and is consistent with the need to achieve the NBU’s inflation targets for the next two years.
Let us look at the current macroeconomic picture
In September, annual inflation stood at 7.9% and was in line with the NBU’s forecast. Inflation has remained in single-digit territory for the sixth month in a row.
The acceleration of headline inflation was mainly attributed to upward adjustments in administered prices, primarily electricity tariffs.
At the same time, inflationary pressures, driven by fundamental factors, continued to ease, further contributing to the slowdown in core inflation to 6.3% y-o-y.
The deceleration in core inflation was underpinned by moderate consumer demand. Retail trade turnover rose by a modest 3.3% year-on-year over the first three quarters of 2016, pointing to weak private consumption.
The slowdown in core inflation was supported by a high supply of food products due to abundant crops and prudent monetary policy.
In October, the FX supply exceeded demand in the FX market. Grain prices failed to recover after falling to a ten-month low in Q3 amid significant carryovers from the previous year and this year’s record-high global grain harvest. Steel prices, although being one-third higher than at the beginning of the year, have lost momentum due to a significant decline in demand from Turkey, Asian countries, Europe, and Persian Gulf countries. However, such an unfavorable external price environment for the domestic FX market was partly offset by an increase in FX proceeds from grain exports.
As a result, the NBU purchased foreign currency to replenish international reserves without counteracting the appreciation trend. With the FX supply exceeding demand in the FX market, the NBU has held 11 FX auctions since the end of September, through which USD 273 million was purchased. Overall, the NBU’s net FX purchases have reached over USD 1.5 billion since the beginning of the year.
Where will inflation go in the period ahead?
The NBU has kept its headline inflation targets for 2016-2018 unchanged.
In the absence of significant unforeseen events, the NBU is on course to meet the year-end inflation target for 2016 (12% +/-3%). Inflation is expected to increase from its current level and return to the target due to the reflection of upward adjustments in statistics for utility tariffs with the start of the heating season in October.
Given significant speculation circulating in social networks, I would like to ease market concerns over the move to transfer part of the NBU profit (UAH 38 billion) to the State Budget by the end of the year by saying that this amount will be transferred in several installments as agreed to with the Ministry of Finance of Ukraine in order to limit its impact on price stability. The NBU profit transfer has already been reflected in the NBU’s inflation forecast.
Given that monetary policy influences macroeconomic variables with a lag, the NBU has already started steering its monetary policy toward achieving the inflation targets set for the next two years.
Annual inflation is expected to follow an erratic path throughout 2017. In Q1-Q3 2017, inflation might exceed 12%, reflecting a statistical base effect and a high contribution from administered prices. As these effects wane, annual inflation is expected to return to the target in Q4 2016 .
At the same time, core inflation is expected to remain stable at 5-6%, underpinned by the appropriate monetary policy.
The assumptions on which the NBU’s inflation forecast is based include a high supply of food products, a gradual revival in domestic consumer demand, and further improvements in inflation expectations.
In 2016, the economic growth forecast remained unchanged at 1.1%.
In the medium-term, GDP is expected to grow at a more moderate pace than expected earlier: 2.5% in 2017 and 3.5% in 2018.
The worsened expectations about a less favorable external environment for Ukrainian exporters have prompted the NBU to revise the GDP growth forecast downward. Sunflower oil and grain prices are unlikely to show a strong rebound after a recent slump due to this year’s record-high global grain harvest. Iron ore prices are expected to fall further due to higher supplies from Brazil and Australia, the world’s largest iron ore exporters. Global steel prices continue to be soft amid a high supply in world commodity markets.
A pick-up in investment activity that has already been observed this year is expected to be the key driver of economic growth. Lower risks of the escalation of the military conflict stimulate economic agents’ appetite to make investment and long-term consumer decisions. However, this will lead to an increase in investment imports, including machinery and equipment.
As a result, net exports are expected to make a negative contribution to GDP. Going forward, a recovery in investment demand will help boost export potential.
Higher investment activity has prompted the NBU to revise the current account deficit forecast to USD 2.5–3.0 billion in the next two-year period.
The overall balance of payments is expected show a surplus in 2016 and in the coming years. The current account deficit is expected to be offset by financial account net inflows.
Ukraine saw an increase in FDI growth in Q3 2016, with FDI inflows being directed not only to the banking sector on account of the recapitalization of the largest banks with foreign capital, but also to the corporate sector.
These developments have led to an upward revision of the FDI growth forecast for 2016 from USD 2.4 billion to USD 3.3 billion. FDI inflows targeting the real sector are expected to retain momentum in the coming years.
These inflows, combined with expected disbursements of future IMF loan tranches, will contribute to the build-up of international reserves. The NBU expects international reserves to increase to USD 17.5 billion by the end of 2016, USD 23.1 billion by the end of 2017, and USD 27.8 billion by the end of 2018.
Further progress in advancing economic reforms under the IMF-supported program remain critical for bringing inflation down to the target level and promoting economic recovery.
Should the baseline forecast scenario materialize and, accordantly, risks to price stability abate further, the NBU will continue to move ahead with monetary easing. This move will help bring down borrowing costs and underpin economic growth.
I would like to draw your attention to the fact that our updated projections will be available in the Inflation Report to be published on 3 November 2016.
The next meeting of the NBU Board on monetary policy issues will be held as scheduled on 8 December 2016.
Thank you for your attention.