The National Bank of Serbia (NBS), which has now cut its rate by 300 basis points this year, added that the decision was taking against the backdrop that the European Central Bank (ECB) recently revised downward its growth projections and the "possibility that the quantitative easing programme will be extended."
At a time of "increased certainty that the Fed will start raising its policy rate," the NBS said the ECB's asset purchases were having a positive impact on liquidity in global financial markets and this had lessened the risks associated with capital flows toward emerging markets.
Serbia's ability to attract global capital has risen due to fiscal consolidation, improved growth prospects, reduced external imbalances and the expectation of another passive assessment by the International Monetary Fund (IMF), the central bank said.
Serbia's inflation rate eased to 1.0 percent in July from 1.9 percent in June, well below the central bank's target range of 2.5 to 5.5 percent, but NBS said inflation expectations remain anchored within its target and the low inflationary pressures reflect low commodity prices, low inflation abroad, the relatively stable exchange rate of the dinar and the impact of fiscal consolidation.
Due to the waning impact of the fall in agricultural prices, inflation is expected to revolve around the lower bound of the inflation target in the coming period before possibly entering the target range late this year and then trend closer to the 4.0 percent central target from mid-2016.
The NBS also cut the foreign exchange reserve requirement ratio by one percentage point in each of the next six maintenance periods. This means that as of Feb. 18, 2016 the ratio on foreign exchange sources with maturities of up to two years will be 20 percent compared with the current 26 percent while the ratio on longer maturities will be 13 percent, down from 19 percent.
With the reserve ratio on dinar-denominated liabilities unchanged, the NBS said it continues to encourage the use of dinar as a source of funding but expects bank to step up their lending activity by lowering the rates on loans approved to clients. This move on the FX ratio also implies further convergence toward the ratios used in neighboring countries and the euro area.
The dinar reserve ratio is 5.0 percent on maturities of up to two years and zero on sources of longer maturities.
The National Bank of Serbia issued the following statement:
"The NBS Executive Board decided in its meeting today to cut the key policy rate by half a percentage point, to 5.0 percent.
After reviewing current monetary and macroeconomic developments and projections, the Executive Board stated that inflationary pressures remain low and inflation expectations anchored within the NBS target. Subdued inflationary pressures reflect in particular low international prices of primary commodities, low inflation abroad, relatively stable exchange rate of the dinar and the effects of fiscal consolidation at home. Though the August increase in electricity prices has pushed y-o-y administered price growth into the positive territory, the contribution of administered prices to inflation this year should be smaller than in the previous years. As a result of past monetary policy easing and the gradual waning of the disinflationary effects of the fall in primary agricultural commodity prices, inflation is expected to revolve around the lower bound of the target band (2.5%) in the coming period, possibly entering the target band in late 2015 or early 2016. Inflation is expected to trend closer to the 4% target from mid-2016.
The Executive Board has assessed that the resilience of the domestic economy towards the risks stemming from the international environment has increased owing in particular to fiscal consolidation, improved economic growth prospects, reduced external imbalances, and the expectation of another positive assessment of Serbia’s arrangement with the IMF (second review).
In light of subdued inflationary pressures, the decision to continue monetary easing – by reducing both the key policy rate and the reserve requirement ratio, shall certainly contribute to Serbia's incipient economic recovery. When making the decision, the Executive Board was also bearing in mind the ECB’s downward revision of the euro area economic growth projection and the possibility that the quantitative easing programme will be extended. In an environment of increased certainty that the Fed will start raising its policy rate, the ECB’s quantitative easing programme has been having a positive impact on liquidity in the international financial market and has lessened the risks associated with capital flows towards emerging economies.
The next rate setting meeting of the NBS Executive Board will be held on 15 October 2015."
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