By CentralBankNews.info
Ukraine’s central bank lowered its key policy rate by 50 basis points to 17.0 percent as it continues its cycle of easier monetary policy toward a rate of 8.0 percent as inflation gradually declines amid prudent fiscal policy, slower wage growth, relatively low energy prices and an ample supply of both domestic and foreign food products.
In April the National Bank of Ukraine (NBU) took the first step onto a monetary easing path by cutting the rate 50 basis points after raising it six times by a total of 550 points between October 2017 and September 2018 to curb inflation from strong wage growth and consumer demand.
But in June NBU paused after inflation topped its forecast two months in a row on a temporary spike in food prices. However, the central bank was still hoping to return to the easing cycle as underlying risk to inflation were falling.
Although inflation dropped to 9.0 percent in June from 9.6 percent in May, consumer demand, production costs and higher administered prices are keeping it high and the central bank said this could slow the process of lowering the key rate to 8.0 percent.
However, NBU still expects inflation to decline toward 6.3 percent by the end of 2019 and then return to its target range in early 2020, hitting the 5.0 percent target by end-2020.
“The NBU’s baseline scenario envisages the key policy rate to decrease further, to 8% over the coming years, provide that inflation steadily declines to the 5% target,” NBU said, adding higher demand for domestic bonds and thus a higher exchange rate of the hryvnia would allow it to lower the policy rate faster than forecast.
The central bank’s rate hikes last year helped boost the hryvnia and lower inflation expectations and continued tight monetary policy will remain the main driver in lowering inflation as it limits pressure from consumer demand.
Since early September 2018 the hryvnia has strengthened and today it was trading at 25.96 to the U.S. dollar, up 6 percent this year and up 9.4 percent since Sep. 4 last year when the trend changed.
On the back of strong consumer demand, expectations of a good grain harvest, NBU raised its forecast for economic growth this year to 3.0 percent from April’s forecast of 2.5 percent and the 2020 forecast to 3.2 percent from 2.9 percent.
However, weak global activity and a decrease in gas transit to European countries from 2020 will still dampen economic growth and widen the current account deficit, NBU added.
Ukraine’s gross domestic product grew 2.5 percent in the first quarter of this year, down from 3.5 percent in the previous quarter.
The National Bank of Ukraine issued the following release:
“The Board of the National Bank of Ukraine has decided to cut the key policy rate to 17.0% per annum effective 19 July 2019. The NBU continues the cycle of monetary policy easing as inflation is declining towards the target of 5%.
After temporary factors caused a deviation from the target in previous months, annual consumer price inflation came in at 9.0% in June 2019, approaching the trajectory of the April forecast.
Core inflation slowed to 7.4% in Q2, which was close to the NBU’s forecast.
The tight monetary policy remained a strong factor that held back underlying pressures on prices, in particular through strengthening of the exchange rate against currencies of trading partners and lower inflation expectations of households, businesses, banks, and financial analysts. At the same time, inflation remained relatively high due to the pressure from consumer demand, production costs, and rapid growth in administered prices.
Inflation will continue to decline gradually.
The NBU reiterates its forecast that inflation will decline to 6.3% as of the end of 2019, return to the target range in early 2020, and reach the medium-term target of 5% at the end of 2020.
The tight monetary conditions will continue to be the disinflation driver. Whereas the key policy rate is reduced gradually, its real value will remain high on the back of improved inflation expectations. High real interest rates will make hryvnia financial instruments more attractive for investors, which will support the exchange rate of the hryvnia. Moreover, such monetary policy stance will limit the pressure from consumer demand.
Other factors behind the gradual disinflation will include:
● a prudent fiscal policy
● the slowdown in wage growth
● relatively low energy prices in the global markets
● ample supply of domestic and foreign food products.
In 2019–2021, the economy of Ukraine will grow steadily, at 3%–4%.
The NBU has revised its economic growth forecast compared to the April macroeconomic forecast to 3% in 2019 (from 2.5%) and 3.2% in 2020 (from 2.9%) amid stronger domestic demand, more favorable terms of trade, and expectations of a larger harvest of grain crops.
Domestic demand will remain the main driver of economic growth over the coming years. Private consumption growth will decelerate, albeit remaining high owing to an increase in real household income – wages, pensions, and remittances from abroad. Capital investment will continue to grow rapidly, which will also provide significant support to the economy.
Economic growth will be dampened by a weak global economic activity and decrease in gas transit to European countries starting in 2020, due to the construction of bypassing gas pipelines.
The 2019–2021 current account deficit will stay within the bounds of reason.
In 2019, the current account deficit will narrow to 2.6% of GDP, thanks to the bumper grain harvest, a drop in energy prices, and a decline in dividend repatriation. In 2020-2021, the current account deficit will widen slightly, as a result of a decrease in natural gas transit, less favorable terms of trade, and stronger consumer and investment demand.
Further cooperation with the International Monetary Fund remains the basic assumption of the macroeconomic forecast.
This will allow Ukraine to attract other official financing, improve the conditions of access to the international capital markets, and support the interest of investors in Ukrainian assets. These borrowings will make it possible for the government to finance large payments on the external public debt. In addition, the private sector will get an opportunity to attract foreign investment.
As a result, international reserves will reach USD 23 billion in 2021.
The main internal risk to the above scenario is the further strengthening of threats to macrofinancial stability.
A delay in implementing key reforms or steps offsetting previous achievements (in particular, court rulings or legislative decisions) might increase the vulnerability of Ukraine’s economy and become an obstacle to further cooperation with the IMF. That could affect exchange rate and inflation expectations as well as the access to international capital markets as Ukraine will face a heavy debt load in the coming years.
The following risks also remain important:
● a suspension of Russian gas transit through Ukraine starting in 2020
● an escalation of trade wars and rising geopolitical tensions
● an escalation of the military conflict, and the imposition of new trade restrictions by Russia.
Considering the revised macroeconomic forecast and the balance of risks, the NBU Board has decided to lower its key policy rate to 17.0%.
The NBU has also approved the decision to start publishing the interest rate forecast when making quarterly reviews of the macroeconomic forecast beginning today.
Publishing the interest rate forecast marks an evolutionary improvement in transparency of monetary policy at central banks that apply inflation targeting. This makes the monetary policy more clear and predictable for market players, thus boosting its effectiveness.
It should be noted that the forecast imposes no obligations on the NBU, and thus the actual key policy rate may differ from the forecast ifmacroeconomic conditions change.
The NBU’s baseline scenario envisages the key policy rate to decrease further, to 8% over the coming years, provided thatinflation steadily declines to the 5% target.
The largest decrease is expected over 2020, along with inflation returning to the target range and inflation expectations improving.
If existing inflation risks, both internal and external, materialize, the key policy rate could decline to 8% more slowly. At the same time, higher demand for hryvnia domestic government bonds from nonresidents and the subsequent strengthening of the exchange rate will allow reducing the key policy rate at a faster pace than envisaged in the baseline scenario.
The decision to cut the key policy rate to 17.0% has been approved by NBU Board Decision No.493-D On the Key Policy Rate dated 18 July 2019.
A new detailed macroeconomic forecast will be published in the Inflation Report on 25 July 2019.
A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 29 July 2019.
The next meeting of the NBU Board on monetary policy issues will be held on 5 September 2019 as scheduled.”
