The Board of the National Bank of Ukraine has decided to keep its key policy rate at 12.5% per annum. The decision reflects the need to mitigate inflation risks to achieving the inflation targets.
Annual headline inflation peaked in June 2017 and is projected to gradually trend downwards.
In June, actual inflation (15.6% yoy) came in above the NBU’s projections, reflecting a sharp increase 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 rose at a faster-than-expected pace as well, reflecting a partial crop loss and changes in the SSSU methodology for calculating the CPI (for more details, follow the link).
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. In particular, prices for fruit and vegetables reported a substantial fall 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.
Meanwhile, inflation was restrained by the strengthening of the hryvnia against the US dollar, which, inter alia, occurred due to favorable global price conditions for commodities, prevailing in Ukrainian exports and improving exchange rate expectations. The latter stimulated households to actively sell foreign currency cash. 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.
Domestic demand, particularly investment and consumer demand, is gradually strengthening. Further output expansion in the construction sector indicates investment activity remained high. High paces of growth in retail trade turnover (9.0% yoy in June 2017) signaled about increasing role of consumer demand in driving economic growth. An increase in wages and an improvement of consumer confidence have contributed to the pick-up in private consumption.
The Inflation Report published in July 2017 envisages annual inflation to decelerate 9.1% by year-end. 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 previously expected. 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. 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, an 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. (For reference: According to the NBU Board‘s Proposals to the Monetary Policy Guidelines for 2018 and Medium Term, the target bands for annual headline inflation 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.
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.
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 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 decision to keep the key policy rate at 12.5% is approved by NBU Board Decision No. 493–D On the Key Policy Rate, dated 3 July 2017.
The next meeting of the NBU Board on monetary policy issues will be held on 14 September 2017 as scheduled.