The National Bank of Ukraine (NBU) has now cut its rate by 800 basis points this year and 1,600 points since it embarked on an easing campaign in August 2015 in response to a decline in inflationary pressures amid a more stable exchange rate of the hryvnia.
Although Ukraine's inflation rate has ticked up due to an increase in administered prices, the NBU said this was built into its forecasts and inflationary pressures had continued to ease, illustrated by a continued decline in core inflation.
"Therefore the inflation targets for 2017 and 2018 (8% +/-2% and 6% +/- 2% respectively) remain within reach and will be supported by the appropriate monetary policy," the NBU said.
Ukraine's headline inflation rate eased to 7.9 percent in September from 8.4 percent in August and 7.9 percent in July while core inflation fell to a 2016-low of 6.3 percent in September from 7.4 percent in August and 7.9 percent in July.
By the fourth quarter of this year the central bank expects inflation to meet its year-end target of 12 percent, plus/minus 3 percentage points, with inflation expected to tick up due to higher utility prices.
Next year inflation is expected to follow "an erratic path," possibly topping 12 percent in the first three quarters due to the rise in administered prices.
But as this impact wanes, inflation is expected to return to the central bank's target in the fourth quarter of 2017 while core inflation is seen stable around 5-6 percent.
The supply of foreign exchange exceeded demand in October, allowing the central bank to purchase more foreign exchange to replenish its reserves without braking the trend toward a higher exchange rate, the central bank said.
Supported by higher foreign direct investment and expected disbursement of funds from the International Monetary Fund (IMF), the NBU forecast that its international reserves will rise o US$17.5 billion by the end of this year, then to $23.1 billion by the end of next year and $27.8 billion by the end of 2018.
A reduced risk of military conflict is helping encourage new investment, which initially will boost imports of machinery and equipment and thus the current account deficit. Longer-term, however, the overall balance of payments should show a surplus and also lead to higher exports.
The central bank maintained its forecast of economic growth this year at 1.1 percent but in following years the economy should grow a little slower than earlier expected due to a "worsened external environment."
In 2017 the economy is seen expanding by 2.5 percent and by 3.5 percent in 2018. In the second quarter of this year Ukraine's Gross Domestic Product grew by an annual rate of 1.4 percent, up from 0.1 percent in the first quarter, reversing eight consecutive quarters of contraction.
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 14%, effective from 28 October 2016. Further alleviation of risks to price stability has given the National Bank of Ukraine some room to further ease monetary policy, which was consistent with the need to achieve its inflation targets in 2017-2018.
In September 2016, annual inflation stood at 7.9% and was fully in line with the NBU’s forecast. The acceleration of headline inflation was mainly attributed to upward adjustments in administered prices.
At the same time, inflationary pressures, driven by fundamental factors, continued to ease, further contributing to the slowdown in core inflation to 6.3% y-o-y.
The deceleration in core inflation was underpinned by moderate consumer demand, high supply of food products due to abundant crops, and prudent monetary policy.
In October, FX supply exceeded demand in the FX market, enabling the NBU to purchase foreign currency to replenish international reserves without counteracting the appreciation trend.
The NBU has kept its headline inflation targets for 2016-2018 unchanged.
In Q4 2016, inflation is expected to return to the target level as a result of the reflection of upward adjustments in statistics for utility tariffs. At the same time, in the absence of significant unforeseen events, the NBU is on course to meet the year-end inflation target for 2016 (12% +/-3%).
Annual inflation is expected to follow an erratic path throughout 2017. In Q1-Q3 2017, inflation might exceed 12%, reflecting a statistical base effect and a high contribution from administered prices. As these effects wane, annual inflation is expected to return to the NBU target level in Q4 2017. At the same time, core inflation is expected to remain stable at 5-6%.
Therefore, the inflation targets for 2017 and 2018 (8% +/-2% and 6% +/-2 %, respectively) remain within reach and will be supported by the appropriate monetary policy.
In 2016, the economic growth forecast remained unchanged at 1.1%. In the medium-term, GDP is expected to grow at a more moderate pace than earlier expected: 2.5% in 2017 and 3.5% in 2018. The weaker GDP growth forecast reflects the revision of assumptions related to a worsened external environment for Ukrainian exporters.
A pick-up in investment activity is expected to be the key driver of economic growth. Lower risks of the escalation of military conflict stimulate economic agents’ appetite to make investment and long-term consumer decisions. However, this will lead to an increase in investment imports, including machinery and equipment. As a result, net exports are expected to make a negative contribution to GDP. However, going forward, a recovery in investment demand will help boost export potential.
At the same time, on the forecast horizon, higher investment activity is a key factor behind the upward revision in the current account deficit forecast at USD 2.5 billion in 2016, USD 2.9 billion in 2017 and USD 2.8 billion in 2018. In 2017-2018, the overall balance of payments is expected show a surplus supported by financial account net inflows, including FDI inflows.
These inflows, combined with expected disbursements of future IMF loan tranches, will increase international reserves up to USD 17.5 billion by the end of 2016, USD 23.1 billion by the end of 2017, and USD 27.8 billion by the end of 2018.
Further progress in advancing economic reforms under the IMF-supported program is critical for bringing inflation down to the target level and supporting economic recovery.
Should the baseline forecast scenario materialize and, accordingly, risks to price stability abate further, the NBU will continue to move ahead with monetary easing. This would help bring down borrowing costs and underpin economic growth.
The decision to cut the key policy rate to 14% is approved by NBU Board Decision No. 372-RSh, dated 27 October 2016, On The Key Policy Rate.
A detailed macroeconomic forecast will be published in the Inflation Report on 3 November 2016.
The next meeting of the NBU Board on monetary policy issues will be held as scheduled on 8 December 2016."