It is the first rate cut by the National Bank of Serbia (NBS) since April 2018, when it wrapped up a 5-year easing cycle from May 2013 after cutting cut the key rate by 8.75 percentage points.
The central bank's executive board said domestic and international economic developments, along with the future prospects, had set up the conditions for the rate cut, and the rate is now at the lowest level since NBS adopted inflation targeting as its monetary strategy in January 2009.
After adopting inflation targeting, NBS was faced with inflation that topped 10 percent during 2011, 2012 and 2013. But in 2014 inflation finally fell and has now been below the bank's target of 3.0 percent, plus/minus 1.5 percentage points for the last six years.
In May inflation dropped to 2.2 percent from 3.1 percent in April, which NBS last month said was the peak for the year, after which inflation is expected to embark on a downward path and move within its target tolerance band - albeit in the lower part - until the end of this year and in 2020.
Low and stable inflation confirms an environment of subdued inflationary pressures along with inflation expectations that fell in June to below the target midpoint.
Internationally, slower economic growth and lower than expected inflation are the main characteristics, which is why the ECB and Fed first decided to slow their pace of rate hikes and now appear increasingly likely to embark on new monetary easing, NBS said.
"A slower pace of normalization or a new round of monetary easing should have a positive impact on conditions in the international financial market and on capital flows to emerging markets," NBS said, underscoring its oft-raised concern that Serbia could face higher borrowing costs in the event of disruptions in global financial markets that lead to a reversal of capital flows.
The National Bank of Serbia published the following statement:
"At its meeting today, the NBS Executive Board voted to cut the key policy rate to 2.75%.
Having analysed economic developments at home and abroad and prospects going forward, the Executive Board assessed that conditions have been met to cut the key policy rate to 2.75%, its new lowest level in the inflation targeting regime. The NBS thereby provides additional support to economic growth. Inflation has been kept firmly under control for the sixth year in a row. In accordance with the Executive Board’s announcements, in May it declined to 2.2% y-o-y. As underscored by the Executive Board, inflation will continue to move within the target tolerance band, most probably in its lower part, until the end of this and in the course of next year. Subdued inflationary pressures are also confirmed by the still low and stable core inflation, as well as financial and corporate sector inflation expectations, which declined further in June and are currently below the target midpoint.
Developments in the international environment are marked by slower economic growth and lower than expected inflation, which is why the ECB and the Fed first announced a slower pace of rate hikes, while now they appear increasingly likely to embark on a new round of monetary easing. The ECB extended the period over which it would keep its key interest rates on hold (at least through mid-2020) and announced other accommodative measures as well. Similarly, the Fed hasn’t raised the target range for the federal funds rate since last December, though market expectations of a rate cut until the end of the year are gaining traction. A slower pace of normalisation or a new round of monetary policy easing should have a positive impact on conditions in the international financial market and on capital flows to emerging markets. Besides, the global oil price declined and futures indicate it is likely to stay close to the current level by the end of the year as well.
The Executive Board stressed that the Serbian economy’s resilience to potential negative effects from the international environment has increased owing to the narrowing of internal and external imbalances and favourable macroeconomic prospects going forward. As in the past two years, public finances are posting a surplus, and in the first five months of 2019 the current account deficit has been fully covered by net FDI inflow. The Executive Board expects this year’s economic growth to be driven by domestic demand, i.e. investment and consumption, and that FDIs, which contribute to the increase in production and export capacities, will result in a gradual narrowing of external imbalances in the medium term.
The next rate-setting meeting will be held on 8 August 2019."
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