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 was prompted by the need to return inflation to the target path.
Let’s have a look at inflation tendencies since the Board's last monetary policy meeting.
In August, annual headline inflation accelerate further to 16.2%. Meanwhile, in monthly terms, the Consumer Price Index (CPI) decreased by 0.1%, reflecting a seasonal decline in the prices of fruit, vegetables, clothing and footwear.
Actual inflation came in above the NBU’s forecast of CPI path published in the July Inflation Report, primarily reflecting faster-than-expected growth in raw food prices and tobacco products. As in the previous months, this was due to the supply-side factors. Unfavorable weather conditions in spring 2017 pushed fruit and vegetable prices up by 40% yoy and 23% yoy respectively, while significant exports of meat and dairy products drove prices for these products up by 32% yoy and 29% yoy, respectively. High growth in prices for tobacco products (by 42% yoy) was due to distribution difficulties seen in recent months.
With the exception of these components, underlying inflationary pressure remained moderate, although core inflation accelerated slightly, driven by supply-side factors and higher production costs. The Core Consumer Price Index increased by 0.2% mom and by 7.8% yoy. As a result, actual core inflation came in slightly above the NBU’s projections published in the Inflation Report, primarily reflecting second-round effects from rising prices for meat and dairy products. Other factors included higher production costs, including higher labor costs that were passed through to prices for services.
However, a further improvement in inflation expectations helped ease inflationary pressures. Overall, their expectations are at historic lows since the surveys were first conducted – 7.2% and 10% respectively.
FX market conditions were yet another factor restraining inflation. The recent strengthening of the hryvnia against the US dollar, which occurred thanks to favorable global price conditions for Ukrainian export commodities and improved exchange rate expectations, stimulated households to actively sell foreign currency cash.
From late August through early September, the hryvnia exchange rate weakened slightly. However, the NBU attributed this weakening to temporary factors. In early September, a number of factors were in play. Thus, businesses received significant VAT refunds, which provided them with hryvnia liquidity and enabled them to reduce FX sales. With a decline in the supply of foreign currency, the FX demand increased, particularly that for foreign currency required for dividend payments.
In addition, a psychological factor was yet another contributing factor as negative past experience gained when the FX market followed a seasonal pattern affected economic agents' behavior.
However, the fundamental factors, primarily the external price environment for Ukrainian export commodities, continue to remain favorable. In particular, global prices for steel, iron ore and grain rose by 57% yoy, 29% yoy, and 10% yoy, respectively. 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.
What is our inflation forecast for the future?
In the latter half of 2017, inflation is expected to trend downwards in annual terms, primarily reflecting last year’s high base of comparison, and the fading effects of inflation surprises.
In addition, the NBU expects moderate volatility of the exchange rate. Reports have been circulating recently that following a seasonal pattern, the hryvnia exchange rate is expected to depreciate sharply this fall. The NBU does not share these concerns.
It is true that the FX market is always subject to seasonality. However, with a floating exchange rate regime in place, the development of the FX market and implementation of reforms in other sectors enable the effect of seasonality to be mitigated.
As a result, the role of factors that are typically in play in the fall has decreased significantly. For instance, Naftogaz NJSC receives sufficient FX earnings and thus exerts no pressure on the FX market through one-off FX purchases. The Ministry of Finance of Ukraine ensures that the settlement of VAT refund claims is more or less equally distributed in time rather than making large one-off payments at the end of the month. Furthermore, FX revenues from agricultural exports typically tend to increase in the fall.
One should not forget that the NBU continues to retain its presence in the FX market to smooth out excessive exchange rate volatility driven by situational factors, if needed. In late August, with the demand for foreign currency exceeding its supply, the NBU held one FX sale auction through which USD 51 million was sold. The NBU’s net FX purchases have amounted to USD 74 million since the beginning of September.
The NBU remains committed to helping the market find equilibrium during the episodes of volatility driven by temporary factors.
As of the beginning of August 2017, Ukraine’s international reserves stood at USD 18 billion, which was sufficient to enable the NBU to conduct FX interventions to smooth out excessive exchange rate volatility if needed.
Why having the above scenario, we decided to leave the key police rate unchanged?
Inflation is expected to decelerate at a slower pace than anticipated in the Inflation Report for July 2017 (to 9.1%). Accordingly, the 2017 year-end inflation is expected to deviate more significantly from the mid-point of the target range (8% ± 2 pp).
In addition, recent months have seen a heightened risk that underlying pressure on prices, particularly demand-driven pressure, will intensify in the medium term.
Consumption, which has picked up markedly on the back of rising wages, is expected to be further boosted by rising budgetary spending and pension payments over the next months.
An increase in the minimum wage has the potential to create inflationary pressure due to higher labor costs that could drive production costs up, especially in the services sector.
Also, current high inflation readings may reverse the trend towards an improvement in inflation expectations seen over the last two years.
In view of the above risks, the NBU Board has decided to keep its key policy rate at 12.5% per annum. However, appropriately tight monetary policy should help anchor inflation expectations and bring inflation closer to the mid-point of the target range in Q2 2018: 7.5% ± 2 pp by the end of Q1 2018 and 7.0% ± 2 pp by the end of Q2 2018).
At the same time, the NBU will continue to closely monitor factors that may increase pressure on inflation and incorporate the expected effect in the updated inflation projections that will be published in the Inflation Report in late October together with other revised macroeconomic forecasts.
What kind of monetary policy is expected in the future?
Further on, the need to return inflation to the target may prompt 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.
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.
However, should demand-driven inflationary pressures increase, including due to a rise in social standards that is inconsistent with economic productivity growth as well as a significant increase in inflation expectations, the NBU may resort to a tighter monetary policy and raise its key policy rate to mitigate inflationary pressures and return inflation to the target level.
Please be reminded that the next meeting of the NBU Board on monetary policy issues will be held on 26 October 2017.
Thank you for your attention!