Thursday, May 26, 2016

Ukraine cuts rate 100 bps, sees more easing if risks abate

   Ukraine's central bank cut its key policy rate by a further 100 basis points to 18.0 percent and said "should risks to price stability abate further, the NBU will move ahead with monetary easing to support the economic recovery."
    The National Bank of Ukraine (NBU) has now cut its rate by 400 points this year, following a 300 point cut in April, and by 12 percentage points since August 2015.
    From April 2014 through March 2015 the NBU hiked its rate by a total of 23.5 percentage points to stem the plunge in the value of the hryvnia and slow down accelerating inflation. Roughly half of the rise in inflation in 2015 was due to higher administered prices and half due to devaluation.
    But since March this year the hryvnia's exchange rate has been appreciating while inflation has been steadily decelerating since hitting 60.9 percent in April 2015 and fell to 9.8 percent last month.
    "The move was made possible due to a steady disinflation trend, which is consistent with the inflation objectives for 2016 and 2017," the NBU said, adding its targets "remain within reach."
    The central bank has targeted inflation to fall to 12.0 percent, plus/minus 3 percentage points, by the end of this year and to 8.0 percent, plus/minus 2 percentage points by end-2107.
    By late 2019 the central bank targets inflation of 5.0 percent, a level that it considers ideal.
    Ukraine's government recently announced an increase of tariffs for heating and hot water, illustrating how administered prices will be a major contributor to inflation the year. Next year the impact of administered prices consumer prices is likely to be less significant.
    But the NBU said it would not pursue a tighter monetary policy in reaction to temporary surges in inflation as higher administered prices, along with "insignificant" pressure from the demand side, will help keep inflation on a downward path.
    The downward trend in inflation has been underpinned by "subdued" consumer demand, the central bank's tight monetary policy and the recent appreciation of the hryvnia, which has benefitted from improved external conditions and thus higher foreign exchange earnings from exports.
    The NBU said continued cooperation with the International Monetary Fund was "critical for achieving price stability," urging the government to move forward in reforms.
    A higher inflow of foreign exchange has allowed the central bank to replenish its foreign reserves without hampering "a gradual appreciation of the exchange rate," the central bank said.
    The hryvnia came under severe pressure in February 2014 following political unrest, the annexation of Crimea by Russia and armed conflict in Eastern Ukraine. Last year it lost 24 percent against the U.S. dollar although capital controls and rate hikes by the central bank slowed its fall.
    But a more stable exchange rate has allowed the central bank to start easing some of the foreign currency controls that were first imposed in August 2014 and then strengthened in February 2015, a move that should help improve business activity and foreign investment.
    On Monday Valeriya Gontareva, NBU governor, said the central bank had gone through radical changes in its monetary policy - including inflation targeting and a strengthening of its financial independence - and it has now moved to a flexible exchange rate fixing with the hryvnia's value solely determined by fundamental factors and the central bank only involved in the market to smooth out fluctuations.
    The hryvnia was trading at 25.1 to the U.S. dollar today, down 4.4 percent since the start of this year but up 8.8 percent since late February. 
    In April the central bank forecast growth this year of 1.1 percent and 3 percent in 2017.

The National Bank of Ukraine issued the following statement:

"The Board of the National Bank of Ukraine has decided to cut the key policy rate to 18%, effective 27 May 2016.  The move was made possible due to a steady disinflation trend, which is consistent with the inflation objectives for 2016 and 2017.

In April 2016, as expected, twelve-month headline inflation slowed to single-digits for the first time in two years, reaching 9.8% y-o-y. However, in monthly terms, inflation was higher than in the previous months, standing at 3.5% m-o-m. The increase in monthly inflation reflected the elimination of preferential natural gas tariffs for households, effective through 31 March 2016. Yet, headline inflation posted only a 5.1% year-to-date increase.

The downward trend in core inflation in April 2016 was in line with the NBU's expectations,, reflecting weakening fundamental factors such as lower inflation pressures.

Disinflation was underpinned by subdued domestic consumer demand, tight monetary policy, and appreciation of the hryvnia exchange rate observed in recent months.

In Q1 2016, real GDP posted a modest increase in annual terms (0.1%), reflecting weaker recovery in domestic demand. Annual GDP growth was slower than projected.

Consumer demand remained subdued, reflecting weaker real wage growth. In March, real wages posted an annualized increase of 1.6% for the first time in two years. However, overall in Q1 2016, real wage growth was 6.8% lower than in the same period a year ago. Although businesses benefited from additional financial resourses released as a result of lower allocations to social funds, the increase in real wages was moderate and insufficient to trigger inflation pressures.

Disinflation was supported by a gradual appreciation of the hryvnia exchange rate, which was underpinned by improved external conditions, and, as a consequence, higher foreign exchange receipts from exports. These developments enabled the NBU, which remained firmly committed to a flexible exchange rate, to purchase foreign currency to replenish its international reserves, while not hampering a gradual appreciation of the exchange rate triggered by fundamental factors.

The NBU believes that the 2016 and 2017 end-year inflation targets set at 12% +/-3% and 8% +/-2%, respectively, remain within reach.

Given the upward adjustment of tariffs for heating and hot water recently announced by the government, administered prices are expected to be a major contributor to the Consumer Price Index in 2016. However, in 2017, their contribution to the CPI is likely to be less significant than projected in the Inflation Report (April 2016).

Increases in administered prices and tariffs accounted for temporary surges in inflation in some months of 2016. However, their further adjustment to cost-recovery levels (market levels) will not require the NBU to pursue a tighter monetary policy. First, in the medium-term, this move will contribute to keeping inflation on a downward path through the elimination of distortions in price-setting mechanisms in the periods ahead. Second, this adjustment will help contain pressures on inflation from households’ effective demand for other goods and services as early as in 2016.

Accordingly, due to this and other factors, the upward pressure on headline inflation from domestic demand-side factors is expected to be insignificant over the forecast horizon. Instead, economic recovery will be driven by investments and supported by external demand.  

The continuation of cooperation with the IMF is critical for achieving price stability. Accordingly, the Government's resolve to move urgent reforms forward and the support of parliament is essential to keeping the program on track.

Should risks to price stability abate further, the NBU will move ahead with monetary easing to support the economic recovery. 

The decision to cut the key policy rate to 18% is approved by NBU Board Decision No. 25-psh, dated 26 May 2016, On Money Market Regulation.

The next meeting of the NBU Board on monetary policy issues will be held as scheduled on 23 June 2016."


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