The National Bank of Ukraine (NBU) has now cut its rate by 650 basis points so far this year and by 1,450 points since starting its easing campaign in August last year in response to easing inflationary pressures and a stabilization of the hryvnia's exchange rate on financial markets.
From April 2014 through March 2015 the NBU raised its rate by a total of 23.5 percentage points, with the key rate topping out at 30.0 percent to support the embattled hryvnia and prevent inflation from getting out of control.
Ukraine's headline inflation rate decelerated further to 6.9 percent in June from 7.5 percent in May, continuing the fall from 60.9 percent in April 2015, and the central bank said actual inflation fell at an even faster pace due to low demand, a gradual appreciation of the hryvnia and high food supply.
The decline in inflation, along with the exchange rate appreciation, also helped lower inflation expectations of households, businesses and the financial community, the NBU added.
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.
The hryvnia started out 2016 on a weak footing but since mid-March it has been rising and was trading at 24.8 to the dollar today, marginally down from 24.0 at the start of this year and unchanged from the NBU's last policy meeting in June.
With international financial markets remaining broadly favorable, the central bank said it was able to continue to replenish its international reserves while not hampering a further rise in the exchange rate. Another relaxation of administrative measures last month did not destabilize the FX market.
The central bank reiterated that it expects inflation to approach its target of 12 percent by the end of this year, mainly due to higher utility tariffs, and then 8 percent by the end of 2017, helped by a slowdown in imported inflation from lower exchange rate volatility and inflation expectations.
Headline inflation may even drop below the 12 percent objective by the end of this year if the impact of subdued consumer demand, high crops and favorable external conditions has a stronger-than-forecast effect on inflation, the central bank said.
The NBU maintained its forecast for economic growth of 1.1 percent by the end of this year and by 3.0 percent by the end of 2017, but lowered its forecast for the current account deficit to US$1.8 billion from $2.3 billion due to lower natural gas imports, better terms of trade, a high crop yield and larger private remittances from abroad.
A detailed forecast will be published in the inflation report on Aug. 4.
The National Bank of Ukraine published the following statement:
"The Board of the National Bank of Ukraine has decided to cut the key policy rate to 15.5 %, effective from 29 July 2016. Further alleviation of risks to price stability enabled the NBU to ease monetary policy, which is consistent with the need to achieve the NBU’s inflation objectives set at 12% +/-3% for 2016 and 8% +/-2% for 2017.
In June 2016, headline inflation slowed to 6.9% yoy. Actual inflation decelerated at a faster-than-projected pace.
Low aggregate demand, a gradual appreciation of the hryvnia exchange rate and a high supply of food products have contributed to the slowdown in inflation.
Real wages resumed growth in annual terms. However, as before, consumer demand did not exert additional pressure on inflation.
With the external conditions remaining broadly favorable, the net foreign exchange supply was recorded in the domestic market. Under such circumstances, the NBU continued to purchase foreign currency to replenish its international reserves, while not hampering a gradual appreciation of the exchange rate. As anticipated, the consequences of June’s relaxation administrative restrictions appeared to be manageable and did not destabilize the FX market.
Also, a high supply of raw foods pushed food prices down in H1 2016.
Overall, these factors contributed to the faster-than expected slowdown in core inflation, having more than offset a contribution from administered prices and tariffs as well as oil prices.
The slowdown of actual inflation, along with the exchange rate appreciation, contributed to improvements in inflation expectations of households, businesses and the expert community.
As previously projected, the medium-term inflation objectives remain unchanged at 12% by the end of 2016 and 8% by the end of 2017.
In H2 2016, annual headline inflation is expected to get close to the target, mainly due to the reflection of the upward adjustments in utility tariffs in statistics.
At the same time, inflation in respect of other consumer basket components (core inflation and raw food prices) is expected to slow at a faster pace. The faster-than-expected deceleration can be attributed to the slowdown in imported inflation in the wake of low exchange rate volatility and improved inflation expectations.
The NBU has also maintained its annual real GDP growth forecast unchanged at 1.1% by the end of 2016 and 3.0% by the end of 2017. However, we revised the current account deficit forecast downwards from USD 2.3 billion to USD 1.8 billion. The downward revision reflected lower natural gas imports, improvements in the terms of trade, projected high yield of crops and larger private remittances from abroad.
The headline inflation might come below the 2016 end-year inflation objective of 12% should assumptions other than those reflected in the baseline forecast scenario materialize. These assumptions include more significant effects of subdued consumer demand, the oversupply in the domestic market resulting from a high yield of crops, and favorable external conditions.
In the medium term perspective, the resumption of cooperation with the IMF, absence of adverse shocks in external markets and de-escalation of hostilities in the east of Ukraine and, as a consequence, further improvements in inflation expectations remain the key factors supporting disinflation.
Should the baseline forecast scenario materialize and risks to price stability abate further, the NBU move ahead with the monetary easing. This move will promote the reduction of borrowing costs and boost economic growth.
The decision to cut the key policy rate to 15.5% is approved by NBU Board Decision No. 172-рш, dated 28 July 2016, On Key Policy Rate.
A detailed macroeconomic forecast will be published in the Inflation Report on 4 August 2016.
The next meeting of the NBU Board on monetary policy issues will be held as scheduled on 15 September 2016."