Dear colleagues,
I would like to greet all the participants at our traditional meeting following the National Bank of Ukraine’s Board meeting on monetary policy.
The NBU Board has decided to cut its key policy rate to 12.5%, effective 26 April 2017. The decision to ease monetary policy is consistent with the pursuit of inflation targets set for 2017-2018 and will help propel the economic growth in Ukraine.
Let’s have a look at inflation tendencies since out last meeting.
As expected, headline inflation slowed to 12.2% yoy in April 2017. The slowdown was primarily due to the waning effect of a number of administered factors. In particular, natural gas tariffs surged in April 2016, which affected this year's comparison base.
However, actual inflation came in slightly below the projected path of annual headline inflation published by the NBU in the Inflation Report (April 2017), envisaging a slowdown in the annual CPI to 9.1% by the end of 2017. The shortfall can be primarily attributed to weaker-than-expected underlying inflation pressures.
Thus, in April, a further strengthening of the hryvnia against the U.S. dollar restrained inflation.
A number of factors remained in play, underpining favorable FX market conditions.
- First, agricultural exports generated substantial foreign exchange revenues. A record high grain harvest and rising global prices helped boost grain and corn exports. A rise in global commodity prices and higher harvest contributed to increased exports of sunflower and sunflower oil.
- Second, Ukraine continued to enjoy significant FX revenues from metallurgical exports despite the negative effect of the halted freight traffic across the contact line in Donetsk and Luhansk Oblasts and the seizure of enterprises in the non-government controlled areas of Ukraine.
- Third, households continued to actively sell foreign currency in the cash FX market, with banks’ net FX purchases having reached USD 982 million since the start of the year. This allowed banks to maintain the foreign exchange supply in the interbank FX market.
- In its turn, the NBU, remaining committed to a flexible exchange regime, did not counteract a gradual appreciation of the hryvnia but has been purchasing an excess supply of foreign currency in the interbank market to replenish international reserves.
The stable situation in the FX market brought about an improvement in inflation expectations. As a result, core inflation remained flat at 6.3% in April, while the NBU had projected it to accelerate slightly.
According to the preliminary estimates of the NBU, inflation in annual terms accelerated in May, which was in line with inflation forecast, published in April.
As expected, a slight acceleration was driven by a rise in raw food prices and and an increase in administered prices and tariffs.
Meanwhile, consumer demand is gradually gaining momentum, which was also incorporated in the macroeconomic forecast approved at the previous NBU Board meeting on monetary policy. Thus, real wages kept increasing, including due to an increase in the minimum wage from the beginning of the year. In March, nominal average wage growth accelerated to 37% yoy, while real wage growth picked up to 19% yoy. As a result, retail trade turnover continues to recover, increasing by 6.1% yoy in April.
Overall, economic growth indicators are close to the NBU projections. In Q1 2017, real GDP rose by 2.4% yoy. The slower pace of GDP growth compared to the end of 2016 can be attributed to the halted freight traffic across the contact line in Donetsk and Luhansk Oblasts and the seizure of enterprises in the non-government controlled areas of Ukraine.
These developments brought about a decline in industrial production and adversely affected the wholesale trade and freight transportation performance. In early Q2, the decline of industrial output deepened to 6.1% in annual terms. Metallurgical and mining sectors, as well as coke production are industries that have been hit hardest. However, such a trajectory of industrial performance was anticipated. It is in line with our forecast, according to which the economic growth will slow down to 1.9% in the current year.
What is our inflation forecast for the future?
The NBU considers that the inflation targets set for 2017 and 2018 (8%+/-2 pp and 6%+/-2 pp, respectively) remain within reach.
The inflation projections published in the last month’s Inflation Report suggest that inflation will slow to 9.1% by the end of 2017 and to 6.0% by the end of 2018. We reckon that the projections remain relevant.
The slowdown in inflation is driven mainly by two factors:
- first, a less significant increase in administered prices in comparison with the last year
- second, relatively tight monetary and fiscal policies.
Meanwhile, a gradual recovery in consumer demand and a rise in raw food prices are expected to pressure inflation upwards.
A recent weakening of US dollar in global markets, which can potentially push up prices of goods that are imported from the EU and Ukraine’s main trading partners, also adds to inflationary pressures.
As before, the NBU expects that the halted freight traffic across the contact line in the Donetsk and Luhansk oblasts will have no significant impact on the headline inflation.
A major risk for the achievement of inflation targets for 2017-2018 arises from a departure from implementing a prudent fiscal policy.
In particular, there is a risk that the government will raise social standards and wages to a level higher than that consistent with inflation targets.
The NBU considers the implementation of a pension reform to be a vital step to ensure sustainable public finances and hence price stability in a long-term perspective. However, over the short-term, a hike in pension payments can push consumer demand up. Consequently, the NBU may be required to adjust its policy to level off short-term repercussions thereof.
Also, a further progress in structural reforms is necessary to preserve the macrofinancial stability, particularly as regards those reforms that Ukraine has committed to implement under the EFF program with the IMF.
Bearing in mind the inflation forecast and the balance of risks pertaining its implementation, the NBU Board has decided to cut its key policy rate to 12.5%.
Looking ahead, the NBU may continue easing the monitory policy, provided the mentioned risks will be diminishing in a sustainable manner.
The speed and the size of a further key policy rate cut will be contingent on the assessment of mid-term risks associated with the achievement of inflation targets in 2017, and, more importantly, in 2018. In contrast to 2016, the key policy rate is expected to decrease less markedly in 2017, at the beginning of which the rate was 14% per annum. It is worth mentioning that in 2016 the key policy rate was cut by 8 pp.
At this, the expected easing of monetary policy, when proceeded, can take different forms - both by reducing key policy rate and relaxing administrative restrictions in the FX market.
The NBU Board considers it feasible to further ease the monetary policy not only through cutting its key policy rate but also by liberalizing FX controls.
The liberalization has been possible in the context of a favorable situation in the FX market, as well as the balance of risks mentioned.
As before, the NBU’s main focus is on removing obstacles to foreign economic transactions and inflows of foreign direct investment.
- First, the regulator plans to extend the maximum settlement period under export and import transactions from 120 to 180 days
- Second, the regulator plans to enable repatriation of funds invested in Ukraine.
Until now, a ban has been put in place on FX purchases and transfers abroad due to foreign investors after the sale of corporate rights, reduction of the statutory capital of legal entities or withdrawal from business partnerships of foreign investors; It is expected that such transactions will be authorized. To prevent the outflow of capital via the shadow schemes, such transactions will be subject to the regulator’s monitoring in terms of their compliance with a specified list of requirements.
- Third, the regulator will allow FX purchases and transfers abroad due to foreign investors under transactions on sale of securities issued in Ukraine.
- Forth, bank customers will be able to effect currency purchases in the interbank market regardless of foreign currency balances held in their bank accounts.
All these steps are expected to improve the country’s investment climate and facilitate operations of companies engaged in foreign trade. At the same time, none of these steps will be contributing to the destabilization of the FX market.
The next meeting of the NBU Board on monetary policy issues will be held on 6 July 2017.
Thank you for your attention!