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Ukraine holds rate but warns of hikes to curb inflation
Thursday, September 14, 2017 6:05
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Ukraine’s central bank kept its key policy rate at 12.50 percent but turned more hawkish in response to accelerating inflation and warned it may “raise its key policy rate to mitigate inflationary pressures and return inflation to the target level.” The National Bank of Ukraine (NBU) has been easing its monetary policy since August 2015 and has cut the key rate by a total of 1,750 basis points since then. But the NBU’s last rate cut was in May and since then inflation has continued to accelerate. Ukraine’s headline inflation rose to a higher-than-forecast 16.2 percent in August, up from 15.9 percent in July and the fourth consecutive month of rising inflation. The rise in inflation was due to higher raw food and tobacco prices along with second-round effects from rising meat and dairy prices along with higher labor costs. In its statement, the NBU repeated its guidance from August that it may keep its policy rate at the current level until there are clear signs of an easing of inflation risks and will resume the easing cycle once inflation risks abate and inflation expectations become well anchored. However, today it also raised the prospects of reversing the recent easing cycle by warning it may “resort to a tighter monetary policy” if inflationary pressures rise. This is a much stronger statement than last month when it said it will “implement a rather tight monetary policy for a longer term to put inflation back on a downward trend.” The NBU pointed to a possible rise in inflationary pressures from higher social standards that are inconsistent with the economy’s productivity growth and higher inflation expectations. Despite the rise in inflation, the central bank still expects inflation to trend downward in the second half of this year as underlying inflationary pressures remain moderate and this year’s rise in the exchange rate of the hryvnia helps restrain inflation. However, inflation is now expected to decelerate at a slower pace than forecast in the July inflation report, which saw inflation easing to 9.1 percent by the end of this year. “As a result, the 2017 year-end inflation is projected to deviate more significantly from the mid-point target range (8% +/- 2 pp for end-2017),” the NBU said, adding demand pressures are likely to rise as consumption is picking up from higher wages, government spending and pensions. It added that it expects inflation to return to the mid-point of its target range in the second quarter of 2018. Last month it expected inflation to return to the midpoint “throughout the first half” of 2018. The central bank targets inflation of 7.5 percent, plus/minus 2 percentage points, by the end of the first quarter of 2018 and 7.0 percent by the end of the second quarter of 2018. After tumbling in 2014 and 2015, the hryvnia has been more stable since March 2016 and risen against the U.S. dollar this year on improved exchange rate expectations and better global conditions for Ukrainian export commodities. A drop in the exchange rate since late August was attributed by the NBU to “temporary and psychological factors, with economic agents’ behavior following a seasonal pattern.” The hryvnia was trading at 26.18 to the dollar today, up 3 percent this year.
The National Bank of Ukraine issued the following statement:
“The Board of the National Bank of Ukraine has decided to keep its key policy rate at 12.5% per annum. The decision was prompted by the need to return inflation to the target path.
In August, annual headline inflation accelerated 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 annual inflation came abovethe NBU’s forecast of CPI path published in the July 2017 Inflation Report, primarily reflecting faster-than-expected growth in raw food prices and tobacco products. As in previous months, this was due to supply factors – the unfavorable weather conditions seen in spring 2017 pushed fruit and vegetable prices up, while significant exports of meat and dairy products led to an increase in domestic prices.
Second-round effects from rising prices for meat and dairy products, as well as higher production costs, including increased labor costs, which were passed through to prices for services, drove core inflation up. Thus, the Core CPI 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 July 2017 Inflation Report.
In spite of this, underlying inflationary pressure remained moderate, due to a further improvement in inflation expectations of both financial analysts and households.
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 and psychological factors, with economic agents’ behavior following a seasonal pattern.
In the latter half of 2017, inflation is expected to trend downwards in annual terms, primarily reflecting last year’shigh base of comparison, the expected moderate volatility of the exchange rate, and the fading effects of inflation surprises.
At the same time, inflation is expected to decelerate at a slower pace than anticipated in the Inflation Report for July 2017 (to 9.1%). As a result, the 2017 year-end inflation is projected to deviate more significantly from the mid-point of the target range (8% ± 2 pp for end-2017).
In addition, recent months have seen an increase in the 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.
Also, the trend towards an improvement in inflation expectations seen over the last two years may reverse, driven by fast price growth.
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 return inflation to the mid-point of the target range in Q2 2018. (For reference: 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.
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 along with other revised macroeconomic forecasts.
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.
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.
The decision to keep the key policy rate at 12.5% is approved by NBU Board Decision No. 593–D, dated 14 September 2017, On the Key Policy Rate.
The next meeting of the NBU Board on monetary policy issues will be held on 26 October 2017 as scheduled.”
