It is the first rate cut by the National Bank of Serbia (NBS) since July 2016 and extends the easing cycle that began in May 2013 when the rate was cut from 11.75 percent for total rate cuts since then of 8 percentage points.
The bank's executive board said its decision was guided by the recent decline in inflation as well as the reduced inflation projection in its August inflation report.
In its latest inflation report, the NBS projected inflation would be lower this year and next year than in its previous report from May but still within its target tolerance band of 3.0 percent, plus/minus 1.5 percentage points.
Under its projection, the NBS saw inflation declining in early 2018 as the one-off hike of some products and services drop out of the comparison while the high base of petroleum product prices also works in the same direction. Countering this are higher prices of agricultural commodities and a gradual rise in aggregate demand.
The NBS maintained its forecast for economic growth for this year of around 3.0 percent and for 3.5 percent for 2018 amid continuing appreciation pressures on the Serbian dinar, this year's fall in the country's risk premium, continued export growth and foreign direct investment.
Serbia's headline inflation rate eased to 3.2 percent in July from 3.6 percent in June while core inflation fell further to 1.7 percent, suggesting low inflationary pressures.
Fiscal policy has also been more favorable than expected, the NBS said, with a surplus of around 2.1 percent in the first half of this year and since its August report, inflationary pressures have eased further due to lower import prices in dinars and the decreased risk premium, which reached its lowest level since it has been monitored.
Serbia's dinar has firmed steadily this year against the euro, reaching levels not seen since 2014, and was trading at 119.5 today, up 2.9 percent this year.
Last week the NBS was reported by dealers to have purchased an unspecified quantity of euros around 119 to the euro to stem the dinar's gains amid strong inflow of investments, remittances and appetite for its government bonds.
The NBS has already bought a total of 905 million euros against the dinar this year.
As in its previous policy statement from August, the NBS said international financial markets are still dominated by uncertainties related to oil markets and the divergent monetary policies of leading central banks that may impact capital flows to emerging economies.
However, today it added international inflation has slowed in recent months and here are no signs of rising inflationary pressures on the demand side and there are no signals that "leading central banks might tighten their monetary policies faster than they had previously announced."
The National Bank of Serbia issued the following statement:
"At its meeting today, the NBS Executive Board decided to lower the key policy rate to 3.75 per cent.
In making the decision, the Executive Board was guided by the lower current inflation as well as the reduced medium-term August inflation projection compared to the May projection, both for this and for the next year.
Low and stable core inflation at the level of around 2% year-on-year, which went down to 1.7% in July, as well as inflation expectations of the financial and corporate sectors which are within the target tolerance band, suggest that inflationary pressures remain low. Fiscal developments have also been significantly more favourable than expected since the beginning of the year, with achieved surplus of around 2.1% of GDP at consolidated level in the first half of the year. Furthermore, relative to the lower August projection, inflationary pressures were additionally reduced based on the lower import prices expressed in dinars and decreased country risk premium, which reached its lowest level since it has been monitored for Serbia.
The Executive Board expects inflation to remain within the tolerance band of 3.0%±1.5 pp in the period ahead. In addition to the above, factors that will also slow down inflation will be the high base of petroleum product prices and the drop out of this year’s one-off price hikes of certain products and services from the y-o-y calculation as of early 2018. For this reason, inflation will move below its current level. In the medium term, a gradual increase in the global prices of primary agricultural commodities and aggregate demand in Serbia will work in the opposite direction.
The NBS Executive Board assessed that movements in the international commodity and financial markets are still fraught with uncertainties, which mandates caution in the conduct of monetary policy. Uncertainties surround global primary commodity prices, particularly oil prices. In the international financial market, uncertainties stem largely from the diverging monetary policies of the leading central banks, the Fed and ECB, which may impact capital flows to emerging economies. However, inflation in the international environment is still low and has slowed down further in recent months, as the effects of energy price hikes wore off. In addition, despite the economic recovery, there are no signals of a rise of inflationary pressures on the demand side or that the leading central banks might tighten their monetary policies faster than they had previously announced.
By lowering the key policy rate amid low inflationary pressures, the NBS provides additional support to credit activity and economic growth.
The next rate-setting meeting will be held on 9 October."
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