The Board of the National Bank of Ukraine decided to raise the discount rate to 18% per annum from September 7, 2018. Despite the sure reduction of inflation since the beginning of the year, the implementation of a number of risks may further hinder this trend. A tightening monetary policy will alleviate the impact of these risks and bring inflation back to the target range at the end of 2019 and achieve the medium-term goal of 5% in 2020.
In July 2018, consumer inflation continued to slow down to 8.9% in the annual terms, moving closer to the target range set by the Fundamental Principles of Monetary Policy for 2018 and the medium-term perspective (6.5% ± 2 pp by the end III quarter of 2018). And, according to preliminary estimates of the National Bank, in August inflation remained close to this mark.
The July drop in inflation was broadly consistent with the latest macroeconomic outlook of the National Bank. This was facilitated by a substantial expansion of the domestic and import supply of food products, due to which prices for them grew at a slow pace. In addition, prices for non-food products affected the strengthening of the hryvnia exchange rate in the first half of the year.
Base inflation in July slowed down to 8.8% in annual terms, which was also expected by the National Bank. However, the still high values of base inflation indicate that substantial inflationary pressures remain. This is primarily a result of the high growth rates of real wages, which leads to an increase in production costs and sustained consumer demand.
The National Bank considers the July forecast for inflation to drop to 8.9% in 2018, its return to the target range at the end of 2019, and the medium-term target of 5% in 2020.
Further deceleration of inflation will be restrained by the expected increase in administratively regulated prices and tariffs, aimed at bringing gas prices closer to the price of imported parity in the fourth quarter of 2018.
As well as during the release of the July forecast, the National Bank continues to believe that price increases will continue to stimulate sustained domestic consumer demand and high inflation expectations.
At the same time, inflation will be restrained by tight monetary conditions that arose as a result of a certain increase in the discount rate, including within the framework of today's decision.
The depreciation pressure on the hryvnia, observed since July this year, will not significantly affect the dynamics of inflation, according to the expectations of the National Bank. In fact, in comparison with the hryvnia, most of the currencies of the countries - the main trading partners of Ukraine during this time depreciated more significantly. Such tendencies in foreign markets undermine the effect that a change in the hryvnia to the US dollar could have on the imported component of inflation.
In addition, the National Bank keeps an active presence in the interbank foreign exchange market - net sales of foreign currency by the National Bank to offset excessive exchange rate fluctuations of over $ 700 million. US from the beginning of the third quarter. Foreign exchange interventions weaken the effect of exchange rate fluctuations on inflation.
The key to reducing inflation to the target remains the successful continuation of cooperation with the International Monetary Fund.
Obtaining credit funds from the fund and related funding from other partners of Ukraine will contribute to strengthening macro-financial stability and will serve as a positive signal for market participants for further progress in implementing reforms in Ukraine.
At the same time, since the July decision of the National Bank's Monetary Policy Board, there has been a significant increase in external risks that could prevent inflation to lowering the target level.
First of all, it is about increasing the pressure on the currencies of developing countries, as a result of the further outflow of capital. This may complicate the access of Ukrainian borrowers to international financial markets and affect the competitiveness of Ukrainian exports. Also, the risks of worsening conditions on world commodity markets are growing due to the escalation of large-scale trade conflicts. The first signs of the realization of this risk are already showing the world steel and oil markets.
In addition, internal risks remain. Due to the growing volatility of the hryvnia exchange rate and the next year's duplicate elections in Ukraine, the possible worsening of inflation expectations may occur. Also, on the hindrance of lowering inflation, according to the forecast of the National Bank, may become a more significant increase in domestic demand due to significant growth rates of wages.
During the last meeting on monetary policy in July, the Board of the National Bank noted that it could further increase the discount rate in case of growth of the probability of realization of inflationary risks. Today, the Board of the National Bank sees an increase in the probability of realizing the above-mentioned risks and considers it necessary to increase the tightening of monetary conditions by raising the discount rate.
At present, the increase in the discount rate by 0.5 pp, in the opinion of the Board, is sufficient to reduce inflation to the target range within the timeframe provided for by the forecast.
In the case of the implementation of inflationary risks, the National Bank may resort to an increase in the discount rate to the level necessary to ensure that inflation is lowered to the set goals in a reasonable time horizon.
An increase in the discount rate to 18% was approved by the Decision of the Board of the National Bank of Ukraine dated September 6, 2018, No. 593-rsh "On the amount of the discount rate".
The results of the discussion of the members of the Committee on Monetary Policy, which preceded the adoption by the Board of this decision, will be made public on September 17, 2018.
The next meeting of the Board of the National Bank of Ukraine on monetary policy will be held on October 25, 2018, in accordance with the approved and published schedule.
06 September 2018