At its meeting today, the NBS Executive Board voted to keep the key policy rate on hold, at 1.0%, and to continue with monetary policy tightening via the repo rate and withdrawal of a larger amount of excess liquidity from the banking sector.
In making such decision, the Executive Board was guided by the fact that the current monetary policy framework gives room to the NBS to reduce the level of monetary policy accommodation amid heightened inflationary pressures both at home and abroad without changing the main interest rates. The NBS has been gradually moving in this direction for the past two months. After it stopped holding securities purchase repo auctions since the beginning of October, by way of which banks were provided with dinar liquidity in the previous period, under very favourable conditions, during the same month the NBS began a cycle of raising the weighted average rate at repo sales of securities. The rate was raised in October by 16 bp from the previous level of 0.11% (which had been its average since the start of the year), to 0.27%, where it stood for the past two reverse repo auctions (by way of which the NBS withdraws excess dinar liquidity from the banking system).
Tightening monetary conditions effectively, without changing the key policy rate and the interest rate corridor, the Executive Board noted that it is important to impact inflation expectations in conditions of cost-push pressures that are stronger than anticipated.
Hikes in the global prices of energy and other primary commodities, halts in supply and significantly higher prices of transportation globally, together with the effects of the low last year’s base, have led to higher cost-push pressures in the global and local markets. Also, in Q3 the seasonally usual fall in vegetable prices in the local market was missing due to draught, and this was what mostly drove y-o-y inflation (5.7% in September) above the NBS’s expectations. Still, the Executive Board stressed that, unlike the majority of other inflation targeting countries in the region, core inflation, which monetary policy measures affect the most, is still in the lower half of the target tolerance band for headline inflation in Serbia (2.6% y-o-y in September), which is mostly attributable to the preserved stability of the exchange rate.
Like most other central banks, the NBS expects that the factors of higher headline inflation will for their major part be temporary in character and that their effect will dissipate next year. Consistent with that, the NBS expects inflation to slow down from Q2 2022, return within the bounds of the target around mid-year and retreat to the lower half of the band before the year’s end. The NBS stands ready to respond promptly by using all monetary policy instruments on hand should any of the risks that would keep inflation above the upper bound of the target band for a prolonged period of time materialise.
In its decision-making, the Executive Board also had in mind that the positive effects of past large-scale monetary and fiscal measures on economic activity, including the third support package for businesses and households, could be expected going forward and that the favourable financing conditions could be sustained at a somewhat lower degree of monetary accommodation. The Board particularly stressed the importance of Serbia’s strong growth dynamics, which outperformed expectations this year, quarter after quarter. As a result, Serbia’s GDP, in NBS estimate, is now by over 3% higher than before the pandemic. As estimated by the SORS, economic activity grew by 7.4% y-o-y in Q3, on the back of the maintained investment and consumer confidence, as well as production capacities and jobs, and the sustained favourable financing conditions and stepped-up execution of government capital expenditure. In light of economic developments since the beginning of the year that proved better than anticipated, the NBS raised its GDP growth projection for 2021 from 6.5% to the range of 6.5–7%. In the medium term, the NBS expects GDP growth within the 4–5% range, which will facilitate further convergence towards EU countries.
The international environment continues to abound in challenges, notably tensions in commodity markets, especially energy and other primary commodity markets, but also persistent logistics problems, imbalances in the labour market and disrupted supply chains, which fuel inflationary pressures in almost all countries of the world. Halts in global supply chains and shortages of some inputs, above all those in the automotive industry, strongly affect the production sector of the euro area, which is our key economic partner. Nevertheless, an encouraging signal s coming from the improvement of economic prospects for the euro area and countries in the region, which are also Serbia's important trade partners, as this should have a positive impact on our exports and economic activity. Although the ECB is not likely to raise its interest rates any time soon, the accelerated euro area growth and higher inflation since the beginning of the year fuel expectations that it might reduce the volume of its asset purchase programme. As the Fed made such decision in early November, this calls for increased caution in the NBS’s monetary policy making.
As so far, the NBS will keep a close eye on developments in the local and international environment. The Board emphasizes that delivering price and financial stability in the medium term will remain a priority of the monetary policy, together with supporting faster growth of our economy and employment, a further rise in the export sector, as well as a favourable investment environment.
In today’s meeting, the Board adopted the November Inflation Report along with new macroeconomic projections, which will be presented to the public in more detail at a press conference on 17 November.
The next rate-setting meeting is scheduled for 9 December 2021.