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The specter of inflation: the National Bank promises to curb the spring surge in 2022

Entrepreneurs and ordinary citizens have recently begun to worry about the rising inflation in Ukraine. Learned by the bitter experience of previous years, everyone fears a rapid total rise in prices for goods and services in the country. Probably, no one wants to go through trials with double-digit percentages of price increases, as in 2017-2018, and even more so to face their one and a half-time rise, as happened in the turbulent 2015.

Concerns arose among our contemporaries back in January against the backdrop of cautious statements by economists about a possible acceleration of inflation in Ukraine in 2021. They strengthened a little later—when in February the State Statistics Service released data on a significant increase in consumer prices for the first month of this year. And recently, these fears have finally grown into a stable suspicion. Especially after the NBU for the first time in the past 2.5 years made a decision to raise the discount rate, and the State Statistics Service for the second time this year have announced a significant increase in the consumer price index.

What is so extraordinary happening now in the domestic economy? And can it somehow threaten production processes or domestic affairs? Or maybe we shouldn't be distracted by such a financial rustle at all?

Rising inflation threat

Let us recall that the monetary policy of Ukraine at the legislative level presupposes the achievement and maintenance of price stability in the state. And this stability, in turn, should be ensured by low stable inflation. The rates of the latter are determined in the National Bank's Roadmap for the transition to inflation targeting, and every year this benchmark, starting from 2017, has been approved in the Basic Principles of the country's monetary policy.

However, a retrospective shows that over the four years of the introduction of the inflation targeting regime in Ukraine, our own inflation was by no means low. After all, its average value during this period reached almost 9% (estimated by The Page, according to the State Statistics Service). Developed countries try to keep inflation at the level of 1-3%, while for developing countries the figure is usually set a few percent higher.

At the same time, inflation in Ukraine during 2017-2021 did not stay at a stable level either. For 49 months, it was only three times within the target range for the medium term, that is, in the corridor of 5% ± 1%. This happened only in November and December 2019, as well as in December 2020. In the remaining 46 months, inflation "jumped" outside the corridor. The amplitude of its fluctuations over 4 years was considerable—from 16.4% in September 2017 to 1.7% in May 2020 (compared to the corresponding month of the previous year). It was not possible to achieve even the softened transitional target markers determined for the first years of the inflation targeting introduction in Ukraine, that is, 8% ± 2% and 6% ± 2% at the end of 2017 and 2018, respectively. Each time, actual inflation was noticeably higher than these markers.

And this time, in the first two months of this year, inflation is again above the target. First, the State Statistics Service reported 6.1% inflation in January, and on March 9—the acceleration of inflation in February to 7.5% in annual terms. Most likely, according to official statistics, food and energy products are becoming more expensive this year. For some items, prices are growing against last year by 30—60%.

The uptrend will, unfortunately, intensify over the coming months.

"In the middle of this year, the growth of consumer prices will reach peak values," Deputy Governor of the National Bank Yurii Heletii says.

Experts explain such a rise in inflation by the growing prices for raw materials and energy resources, the weakening of the hryvnia and the increase in the minimum wage since January by 20%.

There is also a rise in prices on world markets. For nine months in a row, the UN FAO has reported a rise in food prices around the world. From May last year to February 2021, the FAO food price index rose 25 points, reaching a record high of 116 points over the past seven years. It is no coincidence that now in the community of economists, with the participation of specialists from the European Central Bank and the Federal Reserve System, discussions are underway about the threat of the current price surge developing into a new wave of high inflation in the world economy.

Attempts to build positive expectations

The National Bank of Ukraine is trying to assure the public that in our country, despite a significant increase in inflation in the first two quarters, this year it will not jump over the level of 9%, and in the second half of the year it will even begin to decrease. By the end of 2021, according to forecasts of the international agency Fitch Ratings, inflation in Ukraine will be fixed at 6.9%. And only in 2022, the National Bank plans to return inflation to the target corridor of 4—6%. Although quite recently, during 11 months of 2020, it was much lower and did not go beyond the 1.7—3.8% range.

Such chaotic significant inflation variations, and even with significant upward deviations, negatively affect the expectations of the domestic economy subjects. Back in the Q4 of 2020, the National Bank admitted that the enterprises it surveyed expected consumer prices to rise by an average of 7.9% in the next 12 months. At the same time, 20.8% of respondents were preparing for an increase in prices for the year by 7.6—10%, and every tenth enterprise—for an increase of at least 15%.

Probably, now, after the National Bank increased the discount rate to 6.5% on March 4 and the State Statistics Committee reported on March 9 about the acceleration of growing prices for consumer goods to 7.5%, expectations of both enterprises and households will worsen significantly. Especially after the NBU management forecasts regarding further rising inflation growth during the first half of 2021.

Now the bankers are trying to convince everyone that inflation will certainly return to the target range, and this will happen no later than mid-2022.

Quote"The new crop entering the markets, the exhaustion of the effect of a low comparative base for certain goods and an increase in the discount rate will gradually unfold inflationary dynamics," the top manager of the National Bank, Yurii Heletii assures.

It should be noted that if it is "deployed", then it will really be deployed gradually, since all these factors will work no earlier than autumn—winter. The NBU itself has repeatedly emphasized earlier that the change in the discount rate has a greater effect on the inflation rate for 9—18 months. But today, few people look that far. The majority have focused on the spring-summer issues of the current year. And they must do this under the pressure of negative inflationary expectations.

At the same time, it is precisely the expectations that are perhaps the most important factor for the real containment of inflation. They can be even more effective than their own discount rate, experts say.

Recently, the director of one of the leading departments of the NBU publicly admitted that actual presence of inflation in the target range is not the main goal of inflation targeting. Like, the real goal is to build confidence in the central bank and in "anchored" inflationary expectations. According to the banker, the lower the expected inflation rate, the lower it will actually be.

So, the National Bank has stepped up a campaign to build confidence in the effectiveness of the inflation targeting regime. Last year, in fact, was lost, and now they have remembered the problem of trust in their monetary policy and in their own institution. And in the media, lulling interviews and author's columns of the NBU board members have flashed.

But they are perceived mainly as a formal implementation of the February recommendations of the National Bank Council:

Quote"Given the inflation in Ukraine has predictably exceeded the target deviation range of 5% ± 1% in 2021, to enhance the communications of the National Bank to substantiate the admissibility of such changes."

At the same time, this tactic is quite consonant with the proposal of Managing Director of the IMF Kristalina Georgieva regarding the tools for dealing with the current economic crisis.

In her recent blog post on the threat of a "big gap" in the Covid era and the likely further lagging behind most developing countries of the G20, she notes:

Quote"Central banks need to be careful in communicating their plans for monetary policy to prevent excessive volatility in financial markets in their countries."

Forecasts and possible consequences of monetary tightening

The state is moving to a tight monetary policy. The 6.5% discount rate in March is not the limit. The NBU declares its readiness to raise it in the future.

"The National Bank is ready for a more decisive increase in the discount rate to limit fundamental inflationary pressures, stabilize expectations and bring inflation to the target."

Yurii Heletii

Yurii Heletii

Deputy Governor of the National Bank

The experts believe that in April this year the discount rate may rise to 7%.

Such a policy of curbing prices at the same time can lead to negative consequences. In particular, to an increase in the cost of financial resources, a reduction in business lending by commercial banks, etc.

Long-term preservation of the discount rate at 6% and its recent increase instead of relieving tension in financial markets, on the contrary, has only strengthened it, the Chairman of the NBU Council, Academician Bohdan Danylyshyn is convinced.

In particular, it has provoked a deterioration in the transmission of the key rate in the government securities market and does not contribute to the restoration of lending in our country. Not least for this reason, the level of lending to the domestic economy on working loans is one of the lowest in the world, the expert notes.

It is clear that only the discount rate tools and awareness-raising activities are not enough. The economists advise the National Bank to make broader use of the entire arsenal of monetary policy tools. Including overnight resources and incentive refinancing programs. The experts also advise to strengthen coordination between monetary and fiscal policy, improve interaction between the NBU and the government of the country, so that banks eventually increase investments not in foreign assets and government securities, but mainly in the real economy.

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