Thursday, May 25, 2017

Ukraine cuts rate another 50 bps and sees further easing

    Ukraine's central bank cut its policy rate by a further 50 basis points to 12.50 percent and said it may continue easing its monetary policy, with the speed and size of further rate cuts based on how fast inflation falls towards the bank's target this year and in 2018.
     The National Bank of Ukraine (NBU) has now cut its rate 150 basis points this year and by 1,750 points since embarking on its easing cycle in August 2015.
     Last year the central bank cut its key rate by 800 basis points and said it expects to cut the rate this year "less markedly," noting the rate started this year at 14.0 percent. In April the NBU cut the rate by 100 basis points.
      The central bank added that an easing of its monetary policy could take other forms than rate cuts, such as a relaxation of administrative restrictions in the foreign exchange market.
      Ukraine's inflation rate fell to 12.2 percent in April from 15.1 percent in March as the exchange rate of the hryvnia continued to appreciate due to inflow of foreign exchange from agricultural and metallurgical exports despite the negative impact from halted freight traffic and the seizure of companies in the rebel-held easter regions of the country.
      The central bank said its inflation targets for 2017 and 2018 "remain within reach" and disruptions from halted freight traffic should have no significant impact on inflation.
     Inflation in May is likely to accelerate due to higher food prices and administered prices.
     The NBU targets inflation of 8.0 percent, plus/minus 2 percentage points, in 2017 and 6.0 percent, plus/minus 2 percentage points, in 2018. In its April inflation report, the central bank forecast that inflation would slow to 9.1 percent by the end of this year and 6.0 percent by end-2018.
      A major risk to reaching this target comes from the government's fiscal policy, with the NBU saying there is a risk that higher social standards and wages could be raised too much.
      The value of the hryvnia plunged by 66 percent from the start of 2014 to the end of 2015 but has been appreciating since mid-January this year.
     Today the hryvnia was trading at 26.28 to the U.S. dollar, up 2.7 percent since the start of this year, with the NBU saying it has remained committed to a flexible exchange rate regime and not countered the rise in the exchange rate but purchased excess foreign exchange to replenish its foreign reserves, with purchases topping US$1 billion this year.
      The stable situation in the foreign exchange market has helped lower inflation expectations and households have continued to actively sell foreign currency, allowing banks to maintain a supply of foreign exchange. Banks have purchased US$982 million this year, the central bank said.
     Ukraine's economy is also improving as consumer demand gains momentum, with retail turnover up by 6.1 percent year-on-year in April.
     But Ukraine's economy slowed in the first quarter as industrial output was hit by the stop in freight traffic between the government-held part of the country and the rebel-held Donetsk region.
     Gross Domestic Product grew by an annual 2.4 percent in the first quarter of this year, down from 4.8 percent in the previous quarter.

    The National Bank of Ukraine issued the following press release:

"The  Board of the National  Bank of Ukraine has decided to cut the key policy rate to  12.5%, effective 26 May 2017. The decision to ease monetary policy is consistent with the pursuit of inflation targets set for 2017-2018 and will help propel the economic growth in Ukraine.

As expected, headline inflation slowed to 12.2% yoy in April 2017.  The slowdown was  primarily due to the waning base effect (natural gas tariffs surged in April 2016, which affected this year's comparison base).

In April, actual inflation came in slightly below the projected path of annual headline inflation published by the NBU in the Inflation Report (April 2017), envisaging a slowdown in the annual CPI to 9.1% by the end of 2017. The shortfall can be attributed to weaker-than-expected underlying inflation pressures. 

Thus, in April, the hryvnia continued to appreciate against U.S. dollar, underpinned by substantial FX revenues from agricultural exports. Also, Ukraine continued to enjoy significant FX revenues from metallurgical exports despite the negative effect of the halted freight traffic across the contact line in Donetsk and Luhansk Oblasts and the seizure of enterprises in the non-government controlled areas of Ukraine.  Meanwhile, households continued to actively sell foreign currency in the cash FX market, with banks’ net FX purchases having reached USD 982 million since the start of the year.   This allowed banks to maintain the foreign exchange supply in the interbank FX market. 

In its turn, the NBU, remaining committed to a flexible exchange regime, did not counteract a gradual appreciation of the hryvnia but  has been purchasing an excess supply of foreign currency in the interbank market to replenish international reserves. Overall, the NBU’s net FX purchases have reached over USD 1 billion since the beginning of the year.   

The stable situation in the FX market brought about an improvement in inflation expectations. As a result, core inflation remained flat at 6.3% in April, while the NBU had projected it to accelerate slightly.

According to the preliminary estimates of the NBU, inflation in annual terms accelerated  in May, which was in line with inflation forecast, published in April. This acceleration was primarily driven by a rise in raw food prices and an increase in administered prices and tariffs.

In the meantime, consumer demand is gradually gaining momentum, which was also incorporated in the macroeconomic forecast approved at the previous NBU Board meeting on monetary policy. Thus, real wages kept increasing, including due to an increase in the minimum wage from the beginning of the year. As a result, retail trade turnover continues to recover, having increased by 6.1% yoy in April.

Overall, economic growth indicators are close to the NBU projections. In Q1 2017, real GDP rose by 2.4% yoy. The slower pace of GDP growth compared to the end of 2016 can be attributed to the halted freight traffic across the contact line in Donetsk and Luhansk Oblasts and the seizure of enterprises in the non-government controlled areas of Ukraine.  These developments brought about a decline in industrial production and adversely affected the wholesale trade and freight transportation performance.

The NBU considers that the inflation targets for 2017 and 2018 (8%+/-2 pp and 6%+/-2 pp, respectively) remain within reach.

According to the inflation projections published in the Inflation Report last month, inflation is expected to slow to 9.1% by the end of 2017 and to 6.0% by the end of 2018.

Slower regulated price inflation and tight monetary and fiscal policies will be the major driving force behind the disinflation. Meanwhile, a gradual recovery in consumer demand and potential supply-side shocks in global food commodity markets will pressure inflation upwards. A weakening of US dollar in global markets that can potentially push up import prices for goods, also adds to inflationary pressures.

As before, the NBU expects that the halted freight traffic across the contact line in the Donetsk and Luhansk oblasts will have no significant impact on the headline inflation.

A major risk for the achievement of inflation targets for 2017-2018 arises from a departure from the prudent fiscal policy. In particular, there is a risk that the government will raise social standards and wages to a level higher than that consistent with the meeting of inflation targets. 

The NBU considers the implementation of a pension reform to be a vital step to ensure sustainable public finances and hence price stability in a long-term perspective. However, over the short-term, a hike in pension payments can push consumer demand up.  Consequently, the NBU may be required to adjust its policy to level off short-term repercussions of such an increase on price dynamics.  

A further progress in structural reforms, especially those specified as Ukraine’s commitments under the EFF program with the IMF, is necessary to preserve the macrofinancial stability.

Bearing in mind the inflation forecast and the balance of risks pertaining its implementation, the NBU Board has decided to cut its key policy rate to 12.5%.

Looking ahead, the NBU may continue easing the monitory policy, provided the mentioned risks will be diminishing in a sustainable manner.  

The speed and the size of a further key policy rate cut will be conditioned on the assessment of mid-term risks associated with the achievement of inflation targets in 2017, and, more importantly, in 2018. In contrast to 2016 when the key policy rate was cut by 8 p.p., the rate is expected to decrease less markedly in 2017, at the beginning of which the rate was 14% per annum.  

At this, the easing of monetary policy, when proceeded, can take different forms - both by reducing key policy rate and relaxing administrative restrictions in the FX market. 

The key policy rate cut to 12.5% has been approved by NBU Board Decision No. 318-D On the Key Policy Rate of 25 May 2017.

The next meeting of the NBU Board on monetary policy issues will be held on 6 July 2017 as scheduled."



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