Dear colleagues,
I would like to inform you that the Board of the National Bank of Ukraine has decided to hike its key policy rate to 18% per annum, effective from 7 September 2018.
Despite a steady decline in inflation since the start of the year, this trend may be hampered if certain risks materialize. The tighter monetary policy will help neutralize these risks and bring inflation to its target range in late 2019, and achieve the medium-term target of 5% in 2020.
What inflation developments followed the last key policy rate decision?
In July, inflation continued to decelerate, reaching 8.9% yoy and closely approaching the target range of 6.5% ± 2 percentage points as of the end of Q3 2018. According to our preliminary estimations, in August, inflation was also close to this level.
The decline in inflation was generally in line with our most recent macroeconomic forecast published in July. A sizable increase in domestic and imported supply of food products, which dampened price growth, contributed to lower inflation. In addition, hryvnia appreciation in the first half-year influenced prices of non-food products.
Core inflation decelerated in July to 8.8% yoy, which also meets our expectations. However, core inflation remaining high indicates that the underlying inflationary pressure is persistently strong. In particular, household income continues to grow rapidly. In July, the average nominal wage was 25% above the last year’s level while the real wage grew by 15%. As a result, production costs keep rising and consumer demand remains robust.
Will inflation continue to decrease?
We maintain our forecast made in July that inflation will retreat to 8.9% in 2018, return to the target range in late 2019, and meet the medium-term target of 5% in 2020.
Further slowdown of inflation will be constrained by the expected increase in administered prices in Q4 2018, which is aimed at bringing domestic gas prices closer to the import parity price.
Same as in the July forecast, we project that sustained domestic consumer demand and high inflation expectations will continue to bolster price growth.
At the same time, inflation will be curbed by the tight monetary policy conditions determined by the series of key policy rate hikes, including the today’s decision.
We expect that the depreciation pressure on the hryvnia seen since July 2018 will not have much influence on the inflation trend. Currencies of the majority of Ukraine’s main trading partners have depreciated more than the hryvnia, which has weakened by 1.5% against the US dollar since the start of the year. In particular, the Turkish lira depreciated by 78%, the Russian ruble by 18%, the Polish zloty by 7%, the Czech koruna by 5%, and the euro by 4%. These foreign market trends neutralize the impact the changes in the hryvnia exchange rate could have had on imported inflation.
Moreover, the NBU continues to be active on the interbank foreign exchange market. Since the start of Q3 2018, the NBU has sold foreign currency to the amount of more than USD 700 million on net in order to smooth out excessive fluctuations in the exchange rate. Foreign exchange interventions mitigate the effect of foreign exchange fluctuations on inflation.
Continuing cooperation with the International Monetary Fund remains the major precondition for bringing inflation down to the target.
As you surely know, today is the first day of the visit of the latest IMF mission to Ukraine, and the NBU hopes that these negotiations will be successful. New loans from the IMF, and related financing from other Ukrainian partners, are expected to boost the country’s macrofinancial stability.
At the same time, this will signal to other market players that Ukraine is making progress with reforms.
Why did the regulator decide to rise the key policy rate in light of such positive expectations?
Since July’s Board monetary policy decision, there has been a significant increase in external risks, which could prevent inflation from returning to its target.
- First, there is higher pressure on the currencies of developing economies due to further capital outflow. This could affect the competitiveness of Ukrainian products on external markets.
- Second, the risks of less benign global commodity market conditions are also rising, driven by an escalation of large-scale trade conflicts. This could make it more difficult for Ukrainian borrowers to secure financing on the international financial markets, and affect the competitiveness of Ukrainian exports.
Indeed, the first signs that this risk is materializing are already evident on the global metals market – trade conflicts between the United States and China, coupled with the sanctions imposed by the United States on Turkey, have already led to a surfeit of steel and, consequently, a fall in steel prices.
Another sign is the rise in oil prices due to limited oil supplies, resulting both from an escalation in the trade conflict between Washington and Beijing, and tensions between the United States and Iran.
In addition, internal risks also remain important.
- Inflation expectations could worsen, as the volatility of the hryvnia exchange rate increases, and next year’s presidential and parliamentary elections draw near.
- The NBU projects that a significant rise in domestic demand fueled by high wage growth could also prevent inflation from decreasing.
At the previous monetary policy meeting that took place in July 2018, the NBU Board said it could raise the key policy rate further if risks of lower inflation increased. In view of a higher probability that these risks could materialize, the NBU Board deems it necessary to tighten monetary policy by raising the key policy rate.
The NBU Board believes that this rise in the key policy rate is sufficient to bring inflation back to its target within the timeframe set by the forecast.
What will the NBU’s monetary policy stance be in future?
If risks of inflation materialize, the NBU could 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 available on 17 September 2018.
The next meeting of the NBU Board on monetary policy issues will be held on 25 October 2018.
Thank you for your attention!