Dear colleagues,
Please be informed that the NBU Board has decided to maintain its key policy rate at 18% per annum.
We believe that the current and forecast monetary conditions are sufficiently tight to bring inflation to its target of 5% in 2020.
What inflation developments followed the last key policy rate decision?
In November, annual inflation came in at 10.0% and was close to our latest forecast published in October. The acceleration of inflation from previous months was anticipated and driven by several reasons.
First, the underlying inflationary pressure remained high. Last month, core inflation increased slightly to reach 8.9% yoy. It continued being driven by the further growth in production costs, wages in particular, and the pressure from consumer demand.
Second, administered prices were a major inflation factor, as natural gas prices for households grew in November.
What are the future inflation developments?
Inflation is expected to decline and reach the 5.0% target at the end of 2020, as projected in our October forecast.
Tight monetary conditions will be the main factor behind the deceleration of inflation.
In particular, interest rates on hryvnia household deposits continue to grow, as expected, in response to the previous key policy rate hikes. This makes saving more attractive and restrains consumer demand.
That said, pro-inflation risks have weakened since the previous decision due to a number of new favorable factors – both internal and external.
These include:
- The record harvest of corn and sunflower, which will make these crops and related products cheaper (sunflower oil, feed, etc.)
According to the latest data of the Ministry of Agrarian Policy and Food of Ukraine, 34 million tons of corn as of 4 December. This figure beats the previous record of 31 million tons in 2013.
- A drop in global energy prices was another favorable disinflation factor. Brent oil price reached its 4-year high soaring to 86 USD/bbl on 4 October. Since that time, it has fallen by almost a third, to around 60 USD/bbl. This will gradually pass through to domestic prices.
- The US and China reached an agreement to stop raising tariffs, which reduces the risk of global trade wars.
- The US Federal Reserve System is expected to raise its interest rate less aggressively next year.
- FX market conditions are also conducive to slower inflation. These factors, together with a tight fiscal policy, increased the net supply of foreign currency on the interbank market, and a strengthening in the hryvnia exchange rate in November and December.
The impact of the Azov Sea conflict was insignificant and short-term, ceasing to affect the FX market days after a state of war.
The average daily net supply of foreign currency by customers came in at USD 12 million in October, compared to USD 22 million in November and USD 61 million in December. The surfeit of foreign currency on the FX market enabled the NBU to further increase international reserves – since the beginning of Q4, the central bank has purchased over USD 700 million net.
Important is also the significant progress achieved in continuing cooperation with the IMF under a new stand-by arrangement, as well as receiving related financing from other official lenders. This was a key assumption of the NBU’s macroeconomic forecast.
These factors have led to a reasonably fast improvement in the inflation expectations of households, which, however, continue to exceed the central bank’s inflation target by a large margin.
However, there are significant risks which, when materialized, could delay the NBU’s meeting its inflation target:
- robust consumer demand, fueled, among other things, by higher wages, putting further pressure on prices
- a worsening of expectations, due to a new political cycle
- geopolitical risks, such as an escalation of the Azov Sea conflict, which could cut export earnings
- the expected slowdown in the global economy, including in the economies of Ukraine’s main trading partners.
Why did the Board decide to leave the key policy rate unchanged?
When making its previous monetary policy decision in October, the NBU said that it could raise the key policy rate again if inflation pressures did not ease or even built up.
In light of weakening pro-inflation risks, the NBU Board has decided to keep the key policy rate unchanged.
What will the NBU’s monetary policy stance be in future?
The NBU sees that risks to inflation decreasing to its 5% target still remain high.
If these risks materialize, the NBU may raise the key policy rate to a level required to bring inflation back to its target within a reasonable timeframe.
A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 26 December.
The next meeting of the NBU Board on monetary policy issues will be held on 31 January 2019.
Thank you for your time!