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Analysis of Inflation in Ukraine (August 2011)

In August the consumer price index (CPI) decreased by 0.4% (CPI seasonal adjustment was +0.4%). Annual CPI change rates have decreased by 8.9% compared to 10.6% in July, consumer prices have increased by 4.1% since the beginning of year.

The main reason of the CPI drop was a considerable increase of fruit and vegetable product supplies: vegetables and fruit went down in value by 25.6% and 11.5%, respectively. It resulted in decrease of the raw product price index by 3.4% (0.9 p. p. is a contribution to the CPI). Small increase of cereal prices (on the average they decreased by 0.9%) was observed as well. All other raw products went up – the average price growth was 2.7% in August.

Administratively regulated prices and tariffs increased by 0.6% (0.1 p. p. is a contribution to the CPI, on an annualized basis the growth reached 14.1%) due to increase of utility fees, liquefied gas and solid fuel prices. In the world markets, oil prices adhering to the level of previous three months resulted in unchanged petrol prices (on an annualized basis the inflation reached 35%).

Cheapening of raw products has led to decrease of the non-basic CPI by 1.9% (by 9.2% on an annualized basis, 0.8 p. p. is a contribution to the CPI). Increased prices for highly processed food (meat and dairy products mainly) resulted in escalated rates of the basic CPI to 0.8% in August compared to 0.5% in July (0.4 p. p. is a contribution to the CPI). On an annualized basis the core inflation increased to 8.8% (8.6% in July).

However, the demand forced inflation of the basic CPI components into some decrease. Thus, in conditions of the moderate fiscal and monetary policy (aiming to absorb the excess liquidity in the banking system), the consumer demand remained lower than the equilibrium value (the average GDP deviation from the potential value was 0.7% in the first three quarters of this year (according to estimates of the NBU’s Department of Economic Analysis and Forecasting)).

Strengthening of the UAH nominal effective exchange rate (NEER) (in May-July, the strengthening reached 2.3%, according to the NBU’s Department of Economic Analysis and Forecasting) restrained the basic CPI growth. The rate of change of the narrow basic CPI remained low (0.2% per month, 2.9% on an annualized basis).

Restrained price growth on the external raw material markets evidences of low growth rates of producer price indices (PPI) – 0.5% in August and 0.1% in July. However, the PPI annual growth remains high (19.9%). Since the year beginning the PPI has increased by 16.3%

Cost-Push Inflation

Heavy crop of fruit and vegetables (as of August 1 the level of vegetable production was about 15% higher than in the respective period last year) resulted in a significant price reduction. In July-August, vegetables went down in value by 49.9%, and fruit - by 14.7%. In general, prices for potatoes (36.0% monthly), seed vegetables (25.6%), cabbage (24.8%), and fruit, in particular, apples (by 20.3%) decreased. A specific role in price reduction has been played by the government’s encouragement of sales and shelf storage of the agricultural products.

The grain crop was rather high this year (according to forecasts of the Ministry of Agricultural Policy and Food, it was about 50 mln. t), therefore, grain prices are kept constant. Increased grain exports by Russia and Kazakhstan, as well as export duties imposed by the government, reduce the possibility of grain sales to foreign markets by the domestic producers and force them into the domestic market and restraining domestic prices for grain.
However, even despite the mentioned conditions, milk prices are going up slightly (by 1.4%). The reason is continuous reduction of the cattle stock and decrease of the volume of marketed raw milk. Due to decreased import of raw meat, prices for meat and meat products were growing fast (3.3%).

In June, administratively regulated prices and tariffs increased by 0.6% (14.1% on an annualized basis). Utility and accommodation maintenance fees have increased. High demand and reduced import of liquefied natural gas resulted in its continued appreciation (by 1.5 % in August), solid fuel prices have increased (by 1.9%).

Price stabilization on the world oil markets (within May-July, Brent crude oil price varied about USD 114 per barrel) ensured practical fuel price stability in August. Rush crude oil appreciation which started last year and stopped in the first half of this year caused a significant fuel price growth on an annualized basis (by 35%).

While the administratively regulated prices were growing and fuel prices were unchanged, the non-basic CPI decrease by 1.9% per month was fully determined by cheapening of raw materials.

Summer change of the non-basic CPI decreased too (by 13.7% in July) and made up 9.2%.

Demand Inflation

Reduced supply of raw meat and milk and their increased prices resulted in the escalated prices for highly processed meat and dairy products. These secondary effects were main causes for the core inflation increase by 0.8% in August compared to 0.5% in July: the contribution of increased food prices to monthly variations of the basic CPI was 0.6 p. p. The annual rate of core inflation (8.8% compared to 8.6% in July) was mostly affected by appreciation of food products (5.0 p. p.).

Actions of the National Bank of Ukraine aiming to maintain stability on the foreign exchange market, as well as strengthening of the USD against the EUR, ensured strengthening of the UAH nominal effective exchange rate (NEER) (by 2.3% in May-July). It helped to restrain the imported inflation growth.

The narrow basic CPI (prices for non-food goods, except for fuel prices) increased as low as by 0.2% in August, while it was mainly caused by increased prices for pharmaceutical products and specific domestic products (such as children's clothes), which is mainly dependent on supply and/or seasonal increase of demand. On an annualized basis the narrow core inflation is still at the level of 2.9%.

Active actions of the National Bank of Ukraine resulted in a significant reduction of excess liquidity on the interbank market. The achievement of equilibrium level of liquidity enables a better use of possibilities of the interest rate policy of the National Bank of Ukraine for reduction of the inflationary pressure. Overnight market rates on the interbank market have increased and are getting closer to refinancing rates of the National Bank of Ukraine.

For several months, long-term rates have remained close to 14%. If using the current rate of inflation (8.9%) for the real interest rate estimate, this rate will be about 5%. Its slight deviation from the equilibrium level (by 4.5% in the second quarter of this year) characterizes monetary conditions as being close to neutral. Chances of obtaining a loan are substantially managed by the strong requirements to loan security and borrowers’ opportunities. These factors slow down the growth of crediting and, as a result, do not create any additional pressure from the demand side.
In terms of impact on the collective consumer demand, the fiscal policy is neutral: current costs are growing rather slowly (by 4.7% in January-July, compared to the respective period last year). At the same time, the expenses on implementation of infrastructure projects and debt service have increased.

Actual salary growth is weak (in May-July, the average rate of change was 4% on an annualized basis), and according to the NBU’s Department of Economic Analysis and Forecasting, it does not put any additional pressure on the consumer demand.

In general, factors affecting the collective demand help keeping it slightly lower than the potential one (according to estimates of the NBU’s Department of Economic Analysis and Forecasting, the GDP deviation from its potential level was 0.9% in the 2nd quarter), which restrained development of inflationary processes.

Inflationary Expectations

According to results of enterprise polls arranged by the National Bank of Ukraine, in the 2nd quarter of 2011 the inflationary expectations decreased slightly and reached 14.5% on the average for the next 12 months, compared to 14.7% in the previous quarter.

Producer Price Index

Due to the weak external demand (CRB3 index has decreased for the past few months), the producer price index (PPI) growth has been insignificant for a month (0.5%). On an annualized basis the PPI change still remains as high as 19.9%.

Among the PPI components, in June the most intense price growth was observed in steel industry (1.6%, contribution to the PPI was 0.3 p. p.) and food industry (1.1% contribution to the PPI was 0.2 p. p.). Recent price growth mainly reflects the impact of appreciated raw commodities (milk and meat).

Prices of electricity, gas and water production and distribution have decreased by 0.5%.

Source: National Bank of Ukraine