Dear colleagues,
I would like to greet all the participants in this follow-up meeting on the NBU Board’s monetary decision.
I would like to inform you that the Board of the National Bank of Ukraine has decided to leave the key policy rate unchanged at 12.5% per annum. The decision reflects the need to mitigate inflation risks to achieving the inflation targets.
Let’s have a look at inflation tendencies since the Board's last monetary policy meeting
Annual headline inflation peaked in June 2017 and is projected to gradually trend downwards.
Actual inflation came in above the NBU’s projections in June (15.6%), reflecting a faster-than-expected growth in raw food prices.
Prices for meat and milk accelerated further in annual terms, driven by rising global prices and large exports. Prices for fruit and vegetables also rose at a faster-than-expected pace, reflecting a partial crop loss and changes in the SSU methodology for calculating the CPI (for more details, follow the link).
However, there is a high probability that in monthly terms, deflation will be recorded in July that will continue in August, gradually bringing the annual inflation reading closer to the path projected by the NBU.
This is evidenced by a substantial fall in prices for fruit and vegetables recorded in recent weeks, according to SSSU monitoring of selected consumer good prices, as well as web-scrapped data from the online supermarkets collected by the NBU.
Core inflation rose to 6.8% yoy in June, accelerating further in July, according to the NBU estimates. The acceleration was driven by secondary effects from rising raw food prices, higher production costs, including labor costs, as well as a further increase in dwelling maintenance tariffs.
Domestic demand, particularly investment and consumer demand, is gradually strengthening.
Further output expansion in the construction sector indicates high investment activity. The increasing role of consumer demand in driving economic growth is evidenced by a high pace of growth in retail trade turnover (9% yoy in June 2017). An increase in wages and an improvement of consumer confidence have contributed to the pick-up in private consumption. In June, the consumer sentiment index hit two-year high.
Meanwhile, inflation was restrained by the strengthening of the hryvnia against the US dollar, driven by a number of factors:
- First, the appreciation trend was supported by continued favorable global price conditions for Ukrainian export commodities. In particular, global prices for steel, iron ore and grain rose by 35% yoy, 22% yoy, and 26% yoy, respectively. Ukrainian exports also benefited from robust external demand. Thanks to favorable global price conditions mining, smelting and agricultural companies continued to account for over 80% of the average daily volumes of FX sales by exporters despite a seasonal reduction in FX proceeds from agricultural exports.
- Second, improving exchange rate expectations, which stimulated households to actively sell foreign currency cash, also contributed to this trend. Banks’ net FX purchases from households have amounted to USD 1.8 billion since the start of the year. This enabled banks to ensure excess FX supply in the interbank market.
- The weakening of the US dollar in global markets was yet another contributing factor. In particular, the trade-weighted US dollar index has declined by 9% year-to-date, whereas the EUR/USD exchange rate increased from almost parity to USD 1.18-1.19 per 1 EUR. Accordingly, the US dollar has weakened against the currencies of Ukraine’s major trading partners, as well as against the hryvnia.
The NBU, remaining committed to a flexible exchange regime, did not counteract a gradual appreciation of the hryvnia driven by fundamental factors. Overall favorable FX market conditions enabled the NBU to purchase foreign currency to replenish international reserves, with the NBU’s net FX purchases having reached about USD 1.4 billion since the start of the year. Currently, Ukraine’s international reserves stand at about USD 18 billion.
What is our inflation forecast for the future?
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.
Therefore, inflation is expected to meet the announced targets (8% ± 2 pp for 2017 and 6% ± 2 pp in 2018, respectively).
As before, inflation in annual terms is expected to remain rather volatile in the latter half of 2017. In Q3 2017, it is expected to remain in in double-digits but will return to single-digits in Q4 2017.
The main drivers of inflation include an increase in raw food prices in 2017 and an upward adjustment in administered prices in 2018.
Why having the above scenario, we decided to leave the key police rate unchanged?
Since the publication of the Inflation Report the risks have increased that 2017 year-end inflation may deviate more significantly from the mid-point of the target range (8% ± 2 pp) than projected in the Inflation Report (July 2017).
In particular, a rather sharp recovery in consumer demand, which can be further bolstered by a rise in budgetary spending and pension payments in the second half of 2017, poses the risk of increasing underlying inflation pressures. In the first half of 2017, the state budget recorded a surplus of UAH 29 billion, which posed risks that the bulk of expenditures would be spent in the latter half of 2018, including due to recent changes to the State Budget for 2017.
Also, high headline inflation may pressure the trend towards an improvement in inflation expectations, which has been observed in the past two years, to reverse.
However, appropriately tight monetary policy may help anchor inflation expectations and return inflation to the mid-point of the target range throughout the first half of 2018.
According to the NBU Board‘s Proposals to the Monetary Policy Guidelines for 2018 and Medium Term, the target bands are set as follows: 7.5% ± 2 pp by the end of Q1 2018 and 7.0% ± 2 pp by the end of Q2 2018.
What kind of monetary policy is expected in the future?
The need to return inflation to the target may require the NBU to keep its key policy rate at its current level until the central bank sees clear signs of alleviation of inflation risks. The NBU Board is confident that the achievement of price stability is key to sustainable economic growth.
This being said, the NBU Board considers it possible to move ahead with gradual FX liberalization through the relaxation of administrative restrictions provided that this move will not destabilize the FX market.
In particular, the NBU intends to expand the opportunities for banks to perform own FX operations in the interbank market.
To this end, the regulator plans to allow banks to increase the amount of net FX purchases made within one business day from 0.5% to 1% of the bank’s regulatory capital. This move will broaden opportunities for banks to manage their FX position, enabling the NBU to scale down its operations in the FX market and enhancing the ability of the market to find the equilibrium exchange rate.
The NBU will resume its monetary easing cycle once inflation risks abate and inflation expectations become well anchored. This is contingent on continued cooperation with the IMF, which envisages the implementation of structural reforms, as well as the authorities’ commitment to prudent fiscal policy.
At the same time, should underlying inflation pressure increase, the NBU will implement a rather tight monetary policy for a longer term to put inflation back on a downward trend in accordance with the announced targets.
The next meeting of the NBU Board on monetary policy issues will be held on 14 September 2017.
Thank you for your attention!