However, the National Bank of Ukraine (NBU) cautioned against any premature hopes that it will soon start to cut rates, adding that "if fundamental inflation risks increase further, the NBU may resort to further key hikes," pointing to the importance of new inflation projections at its next monetary policy meeting in April.
The NBU raised its key interest rate by 100 basis points to 17.0 percent and has now raised it by 450 points since October 2017 when it embarked on a tightening campaign to prevent inflation expectations and inflation from rising further and restrain buoyant consumer demand.
"The hike is aimed at lowering headline inflation to meet the target over the medium term," the NBU said, describing today's rate hike as "reasonable" because inflation risks have not subsided.
The rate hike was expected by many, but not all analysts, and comes after minutes from the NBU's monetary policy committee meeting in January showed a majority of its members "concurred that the key policy rate might be raised in the near future if there are no strong indications of lowering inflationary pressure" and "the likelihood of monetary policy softening before the end of 2018 is low."
In January Ukraine's inflation rate rose to a higher-than-expected 14.1 percent from 13.7 percent in December and the NBU estimates it will remain high in February due to faster-than-expected increase in food and services prices.
Ukraine's inflation rate accelerated last year after the government doubled the minimum wage and launched a series of initiatives to boost household income and thus consumer demand, with inflation hitting 16.4 percent in September. At the same time, the cost of food rose sharply along while global oil prices began to rise.
But the central bank said it today's rate hike should help inflation decline to 8.9 percent this year and then return to its target of 5.0 percent by mid-2019.
But it cautioned this forecast was subject to risks of a delay to funds from the International Monetary Fund along with the rapid growth in consumer demand and high inflation expectations.
The central bank's rate hikes have helped raise the attraction of hryvnia assets, boosting the inflow of foreign capital. However, the NBU cautioned such inflows can be quite volatile and pose a risk to "the external sustainability of the economy."
After tumbling in 2014 and 2015, the hryvnia strengthened in 2016 and then weakened in 2017.
This year it started on a weak note but as risen since late January and was trading at 26.8 to the U.S. dollar today, up 5.6 percent this year.
Ukraine's economy grew by an annual rate of 1.8 percent in the fourth quarter of last year and in January the NBU forecast 2018 and 2019 growth 3.2 percent growth and 3.5 percent, respectively.
The National Bank of Ukraine issued the following statement:
"The Board of the National Bank of Ukraine has decided to hike its key policy rate to 17% per annum, effective from 2 March 2018.The fourth consecutive increase in the key police rate is reasonable as inflation risks do not tend to subside. The hike is aimed at lowering headline inflation to meet the target over the medium term.
In January 2018, headline inflation accelerated to 14.1% yoy, exceeding the NBU forecast published in the January Inflation Report. According to preliminary estimates, inflation rate remained high in February. This was primarily due to the faster-than-expected growth in prices for food products and services. Faster growth in fuel prices due to a substantial increase in global oil prices and hryvnia depreciation in the past months contributed as well. In January 2017, core inflation accelerated to 9.8% yoy. This was driven by a number of factors: higher production costs amid further rapid wage growth, hryvnia depreciation over several previous months, and accelerated consumer demand.
Monetary policy tightening conducted by the NBU since October 2017 curbed the buildup in inflationary pressure. As expected, higher key policy rate has stimulated growth in bank interest rates and made hryvnia financial instruments more attractive. In particular, this has boosted foreign capital inflows into hryvnia-denominated government securities. It is worth mentioning that short-term capital inflows might, under certain conditions, be quite volatile and pose risks to the external sustainability of the economy. However, the NBU currently assesses these risks as low.
An inflow of foreign capital, together with an increase in exporters’ foreign currency earnings amid benign global environment favorably affected the supply on interbank FX market. This strengthened the exchange rate of the hryvnia to the US dollar.
However, the strengthening of hryvnia against US dollar took place in parallel with the weakening of the latter on the international foreign exchange market. Therefore, the overall movements in the hryvnia exchange rate against the currencies of Ukraine’s main trading partners are not yet conducive to a faster drop in inflation.
The NBU believes that the January forecast that inflation will retreat to 8.9% in 2018 and will return to the target in mid-2019 remains relevant.
At the same time, the inflation risks the NBU considered when making its policy decision in January still persist. These include:
· high vulnerability of the Ukrainian economy as the next tranche under the EFF program with the IMF is further postponed
· high inflation expectations of economic agents
· the rapid growth in consumer demand.
When making its last policy decision, the NBU Board said that if there were no clear signs of lowering inflation pressure in the near future, the central bank might tighten its monetary policy further in order to bring inflation back to its mid-term target.
In view of the need to offset the influence of these risks and to curb inflation, the NBU has decided to increase the key policy rate to 17% per annum.
As a result, the NBU believes that after several policy rate increases, which began in October 2017, the current monetary conditions are sufficiently tight to bring inflation back to its mid-term target, as projected in the January 2018 Inflation Report.
However, if fundamental inflation risks increase further, the NBU may resort to further key rate hikes. The next key rate decision, which will be taken in April 2018, will factor in new macroeconomic projections, inflation projections in particular.
The NBU Board is convinced that achieving price stability is a precondition for sustainable economic growth. In particular, an improvement in inflation expectations is the main driver for loan interest rates to decrease in the mid-term.
The decision to raise the key policy rate to 17% has been approved by NBU Board Key Policy Rate Decision No. 133-D, dated 1 March 2018.
The next meeting of the NBU Board on monetary policy issues will be held on 12 April 2018 as scheduled."
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