Dear colleagues,
Please be informed that the NBU Board has decided to keep the key policy rate on hold at 17.0%. After four hikes of the key policy rate, the current monetary conditions are sufficiently tight to bring inflation back to its mid-term target.
Let’s take a look at the inflation trend of last month.
In March, headline inflation continued to slow and stood at 13.2% yoy. At the same time, it still exceeded the NBU’s targets. Core inflation was also elevated (9.4% yoy), as in the previous months.
Persisting rapid growth in food prices was the main reason behind the high inflation readings. This was due to a pickup in exports of food products while output of some agricultural goods decreased. Continued growth in production costs, particularly labor costs, also contributed to the inflationary pressure. Consumer demand recovering fast on the back of improved social standards affected prices as well. Respectively, inflation expectations of some economic agents remained high.
However, the NBU’s tight monetary policy restrained inflationary pressure, in particular via the exchange rate channel. The previous key policy rate hikes have expectedly made hryvnia financial instruments more attractive, which encouraged foreign capital inflows.
Alongside, foreign currency revenues from exports increased gradually thanks to prices for metals, ores, and grains remaining high despite a recent price adjustment. That said, the mining and metals industry accounted for 46% of sold foreign currency in March. Another 36% were sold by agricultural companies that purchased more foreign currency to prepare for the sowing campaign. In addition, businesses sold foreign currency in order to pay taxes, particularly the income tax for 2017.
These factors have determined a rebound in the hryvnia exchange rate that made the domestic currency strengthen both against the US dollar and the currencies of Ukraine’s trading partners. These developments were reflected in prices of fuel and imported goods. These developments were reflected in the prices of fuel and imported goods and are expected to have a positive influence on future inflation expectations.
When the supply of foreign currency exceeded the demand, the NBU conducted foreign exchange interventions to replenish international reserves. Increasing international reserves enhances the NBU’s potential of maintaining the macroeconomic stability (particularly in case of capital flows reversal) and meeting the inflation targets in the medium terms. Since the start of the year, the NBU has purchased more than USD 1 billion of foreign currency, on net, in order to increase the reserves. At that, we did not interfere with the market-driven exchange rate trends.
What is the future inflation trend?
We have left the headline inflation forecast unchanged. In 2018, inflation will decelerate gradually to 8.9% in December, albeit remaining above the target.
- On one hand, the hryvnia appreciation in the first quarter will curb price growth, primarily for non-food goods, and will thus contribute to core inflation declining faster than forecasted in January.
- Moreover, we believe that previous decisions to hike the key policy rate have not been fully reflected in interest rates yet. For this reason, inflation will be reined in by further increase in interest rates on commercial bank deposits.
- On the other hand, inflationary pressure will be maintained by a higher-than-expected growth in food prices amid increased exports and stronger consumer demand driven by higher household income.
Further, Inflation will decrease thanks to the continued tight monetary policy, a rise in supply of food products, and a deceleration in imported inflation.
As a result, inflation will return to its target range in the middle of 2019 to make 5.8% by the end of the year.
In 2020, inflation will slow to 5.0%, thus hitting the central point of the target range (5.0% ± 1 pp).
The NBU has made no change to its economic growth projections for 2018–2020
The Ukrainian economy grew by 2.5% in 2017, exceeding the NBU’s expectations. The economic growth was fostered by the expansion of domestic consumer demand and high investment activity.
Same as before, the NBU forecasts real GDP to increase further to 3.4% in 2018.
Private consumption will remain the main driver of economic growth.
- First, real wages will continue increasing at a fast pace, spurred by intensive labor migration.
- Second, the fiscal policy is easing on the back of higher social standards and other factors.
- Additionally, companies will continue to invest actively.
Real GDP growth is projected to slow to 2.9% in 2019 – 2020. This will be due to fiscal easing effects wearing off and the central bank conducting a reasonably tight monetary policy to bring inflation back to the target. However, economic growth could be higher if more decisive action is taken to implement structural reforms.
Exports are expected to rise further, driven by favorable terms of trade, a bumper crop, and Ukrainian companies gaining more access to external markets. Nevertheless, import growth is expected to outperform that of exports, as domestic consumer and investment demand expands and the real effective exchange rate gradually strengthens.
This will widen the current account deficit moderately, from 1.9% of GDP in 2017 to 2.6% of GDP in 2020. A widening in the external trade deficit will be partly offset by a rise in remittances on the back of a further increase in the number of labor migrants, resulting, among other things, from eased employment conditions in neighboring countries.
A key assumption of the above scenario is continuation of carrying out structural reforms and receiving funding from the International Monetary Fund. This will in turn allow Ukraine to receive official financing from other institutions, and have access to international capital markets over the forecast horizon.
In 2018, the NBU expects that Ukraine will receive about USD 2 billion in IMF loans, as well as loans from the European Union and the World Bank. This will push up international reserves to USD 21.6 billion in late 2018.
However, in 2019–2020, the balance of payments is expected to run a deficit and international reserves will decrease slightly amid peak repayments on external public debt.
The NBU believes that the main risk to the said macroeconomic forecast is that there may be no progress in implementing structural reforms, which is required for maintaining macroeconomic stability and receiving loans from the IMF.
Any delays in taking the required steps to revive cooperation with Ukraine’s official lenders narrows the country’s opportunities to receive financing required for making public debt repayments, which will peak in 2018-2020. Therefore, the NBU deems that stepping up efforts to revive cooperation with the IMF is critical to maintaining macrofinancial stability in Ukraine.
Another risk is that the government may ease its fiscal policy. In particular, further growth in social spending at a pace higher than that of labor productivity may increase inflationary pressures.
Global risks of large-scale trade wars have risen significantly. This could cause dramatic fluctuations in global commodity prices, restrict access to external markets for Ukrainian exporters, and consequently, decrease foreign exchange earnings. A reversal in the favorable trends that have persisted in the global economy since early 2016 could have negative implications for the Ukrainian economy, which remains vulnerable to changes in external conditions.
Why did the Board decide not to change the key policy rate despite the above risks?
The Board believes that current monetary conditions are tight enough to reduce inflation in the mid-term.
However, if underlying inflation risks increase further, the NBU may raise the key policy rate again in order to bring inflation back to its target.
As before, the central bank will seek to strike a balance between the need to reduce inflation and to minimize short-term negative consequences for economic growth and a resumption of lending. The NBU believes that delivering price stability and improving inflation expectations are the fundamental prerequisites for a fall in loan rates, a recovery in lending, and sustainable economic growth in the mid-term.
A more detailed new macroeconomic forecast is included in the central bank’s Inflation Report, which will be published on 19 April 2018, as scheduled.
A summary of the discussions by Monetary Policy Committee members that preceded this decision will be available on 23 April 2018.
The next monetary policy meeting of the NBU Board will be held on 24 May 2018.
Thank you for your attention!