Please be informed that the Board of the National Bank of Ukraine has decided to keep its key policy rate unchanged, at 17.5% per annum.
This decision was required to neutralize inflation risks, which have increased since the previous decision taken in April, and to attain the 5% inflation target next year.
Let’s consider the latest developments
Consumer price inflation has been above the NBU’s forecast for two months running. In April, its annual reading was 8.8% and it continued to accelerate in May, according to NBU estimates. However, the acceleration is mostly driven by temporary factors, which include higher prices for some vegetables and fuel. In H2 2019, the effect of these factors will fade away as the new harvest becomes available for sale and global energy prices go down.
Underlying inflationary pressures continued to decrease gradually. This is reflected in core inflation declining since the start of the year, which is in line with the NBU’s forecast. Inflation expectations have also improved a little.
At the same time, domestic demand continued to grow rapidly. This was evidenced by the recent high growth in wages, retail turnover, construction, and industrial production. In particular, in April the average wage increased by 21% yoy. Meanwhile, retail trade turnover rose by about 9% yoy in the past months.
Financial market volatility has also risen in recent weeks. Although, overall, the hryvnia has strengthened by 3% since the start of the year, in May it weakened by 1.4%. This was due to several factors.
- First, speculative information about external public debt was spread in the media.
- Second, deliberations regarding the continuation of IMF financial support were put off until a new government is formed.
- Third, rulings made by courts, and lawsuits filed at them, are casting doubt on the consistency of the NBU’s policy for ensuring that the banking system is stable, transparent, and effective. Such court rulings and lawsuits are increasingly threatening financial stability.
The financial markets could not help but notice these developments, and responded with increased volatility.
What will be the future trajectory of inflation?
The macroeconomic forecast the NBU published in April envisages that inflation will gradually slow to 6.3% by late 2019, hitting 5.0% in late 2020. The continued fulfillment of Ukraine’s obligations under its cooperation program with the IMF was the basic assumption of the macroeconomic forecast.
However, any deliberations regarding further financial support from the IMF and related financing have been put off until a new government is formed. This is making the Ukrainian economy more vulnerable, and could increase financial market volatility.
The NBU also noticed that domestic demand was rising. This could curb any further weakening of underlying inflationary pressures.
In addition, both external and internal risks remain substantial, as the NBU pointed out when making its previous monetary policy decision. Among other things, uncertainty persists in the country, which is usually the case during an election period.
The following external risks remain relevant:
- global recession and lower raw commodity prices
- persisting geopolitical tensions, particularly due to trade conflicts
- uncertainty over the volume of gas transit through Ukraine starting in 2020, as pipelines bypassing the country are being built to deliver gas to Europe
- the development of the military conflict and new trade restrictions introduced by Russia.
What will the NBU’s monetary policy stance be in future?
In late April, the NBU announced that it was launching a monetary easing cycle. Today, the NBU Board thinks that this cycle could continue.
But only if inflation risks decrease and inflation expectations improve steadily.
The NBU’s updated macroeconomic forecast, which will be published in July 2019, will take into account the possible impact from sustained consumer demand growth on future price movements, stronger volatility on the financial markets, and any other potential factors. In July, the central bank will also say what monetary policy measures are required to offset these factors.
A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 17 June 2019.
The next meeting of the NBU Board on monetary policy issues will be held on 18 July 2019.
Thank you for your attention!