Please be informed that the NBU Board has decided to leave the key policy rate unchanged at 17.0% per annum. We have decided to maintain the key policy rate at the same level for the second time in a row as we believe that four preceding rate hikes made the current monetary conditions sufficiently tight to bring inflation to its medium-term target.
What inflation trends followed the last key policy rate decision?
In April, inflation continued to decrease, as expected. It decelerated to 13.1% yoy, slightly deviating from the NBU’s April forecast. The deviation was caused by the most volatile components of inflation, primarily prices for raw food products. In April, their growth rates were still high, partly due to a shortage in supply of some products on the domestic market and larger exports, and partly to the sustained pickup in consumer demand.
At the same time, the NBU’s tight monetary policy continued to contain the underlying inflationary pressure. This was reflected in the core inflation measure that remained unchanged in April, at 9.4% yoy, and was in line with our most recent projections.
The effect of the tight monetary policy has been the strongest in the exchange rate channel, with the hryvnia having strengthened since the end of January 2018. High prices for Ukrainian exports – metals, ores, and grains – supported this trend on the foreign exchange market. In particular, metals and mining companies sold the largest amounts of foreign currency on the interbank market amid favorable external environment. Banks provided additional supply of foreign currency, becoming more active on the interbank foreign exchange market thanks to the recent changes that expanded their capability to perform their own foreign currency operations.
These factors have made the hryvnia strengthen both against the US dollar and the currencies of Ukraine’s trading partners. These developments were reflected in prices of fuel and imported goods.
When the supply of foreign currency exceeded the demand, the NBU took the opportunity to increase the international reserves as needed to ensure the macrofinancial stability, while creating no pressure on the exchange rate. Since the start of the year, the NBU has purchased more than USD 1.2 billion of foreign currency, on net, in order to increase the reserves.
The consistent monetary policy and the situation on the foreign exchange market have also led to signs of some improvement in inflation expectations. Projections by households, banks, and financial analysts for the following 12 months have become closer to our forecast.
What are the future inflation developments?
We expect that the April’s deviation of headline inflation from the forecast will vanish in the coming months and headline inflation will continue to decline gradually in line with the NBU forecast published last month. Specifically, we estimate that inflation will decelerate markedly in May, reflecting both the statistical base effect and a significant drop in food prices.
It will make 8.9% as of the end of 2018 and will return to its target range in mid-2019. This will be further driven by the monetary conditions, which are already sufficiently tight.
At the same time, this forecast will remain relevant only if its key assumption materializes, which is the sustained progress in structural reforms, particularly under the IMF’s Extended Fund Facility.
These reforms are critical for both maintaining the macrofinancial stability and ensuring the long-term economic growth in Ukraine. The near future will be crucial for taking decisions that are important for extending cooperation with Ukraine’s official lenders.
The need for this cooperation has become stronger as developing countries’ access to the global capital market is narrowing. Investors have become less interested in these countries over the last 6–8 weeks on the back of expectations of faster monetary policy tightening by the Federal Reserve, increased geopolitical tensions, protectionism across the world, and renewed US dollar appreciation. Capital inflows to developing countries drained last month, while their borrowing costs are on a rise.
With the limited access to the global capital markets, Ukraine must make every effort to implement reforms and revive cooperation with the IMF, which is the prerequisite for investment climate improvement.
Why did the Board decide not to change the key policy rate despite the above risks?
The NBU Board believes that, provided that assumptions of the baseline scenario materialize, the current monetary conditions are already tight enough to reduce inflation over the medium term.
Alongside, if risks to lower inflation and macrofinancial stability rise, including due to a lack of progress in structural reforms and access to official financing, the NBU may hike the key policy rate to the level sufficient to drive inflation back to the established medium-term targets.
A summary of the discussions by Monetary Policy Committee members that preceded this decision will be available on 4 June 2018.
Also, the schedule of the NBU Board meetings on monetary policy issues for 2019 will be published on the NBU’s web-site later today.
The next meeting of the NBU Board on monetary policy issues will be held on 12 July 2018.
Thank you for your attention!