The National Bank of Ukraine (NBU), which has now raised its rate by 350 basis points this year, added domestic risks to lower inflation were also behind the rate hike, including a rise in inflation expectations from a lower exchange rate, government spending ahead of next year's presidential and parliamentary elections, along with higher than expected domestic demand from higher wages.
"If risks of inflation materialize, the NBU could raise the key policy rate again to a level required to bring inflation back to its target within a reasonable timeframe," said NBU.
In its previous policy statement from July, the central bank's board said it could continue raising rates if new threats to inflation or financial stability emerged.
The 50-basis-point hike in July surprised investors and today's hike came after NBU in early August said monetary policy was tight enough to prevent a rise in inflation in the second half.
"In view of a higher probability that these risks could materialize the NBU board deems it necessary to tighten monetary policy by raising the key policy rate," the central bank said today.
The most significant risk stems from higher pressure on the currencies of developing economies from capital outflows, which makes it more difficult for Ukrainian borrowers to secure international financing and thus impacts the competitiveness of Ukrainian exports.
In addition, global steel and oil markets are reverberating from global tensions, with U.S. policies toward China and sanctions on Turkey leading to lower steel prices, and oil prices rising due to "an escalation in the trade conflict between Washington and Beijing, and tensions between the United States and Iran," NBU said.
The central bank said it believes today's rate hike is sufficient to bring inflation back to its target and maintained its forecast for inflation to ease to 8.9 percent this year before returning to the target range of 4.0 - 6.0 percent in late 2019 and meeting the 5.0 percent target in 2020.
Ukraine's inflation rate fell to 8.9 percent in July from 9.9 percent in June and 13.7 percent at the end of last year while the exchange rate of the hryvnia rose in response to the rate hike.
The hryvnia was trading at 28.24 to the U.S. dollar today, unchanged from 28.25 at the start of the year after rising in the first two months and then falling since mid-July.
The National Bank of Ukraine released the following statement:
"The Board of the National Bank of Ukraine has decided to hike its key policy rate to 18% per annum, effective from 7 September 2018. Despite a decline in inflation since the start of the year, this trend may be hampered if certain risks materialize. The tighter monetary policy will help neutralize these risks and bring inflation to its target range in late 2019 and to achieve the medium-term target of 5% in 2020.
In July 2018, consumer price inflation continued to decelerate, reaching 8.9% yoy and closely approaching the target range set in the Monetary Policy Guidelines for 2018 and the Medium Term (6.5% ± 2 pp as of the end of Q3 2018). According to the NBU’s preliminary estimations, in August, inflation was also close to this level.
The decline in inflation in July was generally in line with the most recent macroeconomic forecast of the NBU. A sizable increase in domestic and imported supply of food products, which dampened price growth, contributed to lower inflation. In addition, hryvnia appreciation in the first half-year influenced prices of non-food products.
Core inflation decelerated in July, to 8.8% yoy, which was also expected by the NBU. However, core inflation remaining high indicates that the underlying inflationary pressure is persistently strong. This is mainly the result of the rapid growth in real wages, which leads to higher production costs and sustained consumer demand.
The NBU maintains its forecast made in July that inflation will retreat to 8.9% in 2018, return to the target range in late 2019, and meet the medium-term target of 5% in 2020.
Further slowdown in inflation will be constrained by the expected increase in administered prices in Q4 2018, which is aimed at bringing domestic gas prices closer to the import parity price.
Same as in its July forecast, the NBU projects that sustained domestic consumer demand and high inflation expectations will continue to bolster price growth.
At the same time, inflation will be curbed by the tight monetary policy conditions determined by the series of key policy rate hikes, including the today’s decision.
The NBU expects that the depreciation pressure on the hryvnia seen since July 2018 will not have much influence on the inflation trend. This is due to the fact that currencies of the majority of Ukraine’s main trading partners have depreciated more than the hryvnia over this time. These foreign market trends neutralize the impact the change in the hryvnia exchange rate against USD could have had on imported inflation.
Moreover, the NBU continues to be active on the interbank foreign exchange market: since the start of Q3 2018, the NBU sold foreign currency to the amount of more than USD 700 million on net in order to smooth out excessive fluctuations in the exchange rate. Foreign exchange interventions mitigate the effect on foreign exchange fluctuations on inflation.
Success in continuing cooperation with the International Monetary Fund remains the major precondition for bringing inflation down to the target.
New loans from the IMF, and related financing from other Ukrainian partners, are expected to boost the country’s macrofinancial stability and signal to other market players that Ukraine is making progress with reforms.
However, since July’s Board monetary policy decision, there has been a significant increase in external risks, which could prevent inflation from returning to its target.
The most significant risk here is higher pressure on the currencies of developing economies due to further capital outflow. This could make it more difficult for Ukrainian borrowers to secure financing on the international financial markets, and affect the competitiveness of Ukrainian exports. The risks of less benign global commodity market conditions are also rising, driven by an escalation of large-scale trade conflicts. The first signs that this risk has started to materialize are already evident on the global steel and oil markets.
In addition, internal risks also remain important. Inflation expectations could worsen, as the volatility of the hryvnia exchange rate increases, and next year’s presidential and parliamentary elections draw near. Domestic demand rising at a faster pace than projected, due to high wage growth, could also prevent inflation from decreasing.
At the previous monetary policy meeting that took place in July 2018, the NBU Board said it could raise the key policy rate further if it saw an increase in the probability that risks of inflation would materialize. In view of a higher probability that these risks could materialize the NBU Board deems it necessary to tighten monetary policy by raising the key policy rate.
The NBU Board believes that raising the key policy rate by 0.5 pp is sufficient to bring inflation back to its target within the timeframe set by the forecast.
If risks of inflation materialize, the NBU could raise the key policy rate again to a level required to bring inflation back to its target within a reasonable timeframe.
The decision to raise the key policy rate to 18% has been approved by NBU Board Key Policy Rate Decision No.593-D, dated 6 September 2018.
A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 17 September 2018.
The next meeting of the NBU Board on monetary policy issues will be held on 25 October 2018 as scheduled."
The central bank also released Governor Yakiv Smolil's speech at today' press briefing:
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