At its meeting today, the NBS Executive Board voted to raise the key policy rate by 25 bp to 2.75%. The lending facility rate now equals 3.75% and the deposit facility rate 1.75%.
Today’s decision maintains continuity of the ongoing process of the tightening of monetary conditions. With a more moderate rate increase than in recent months, the NBS continues to respond to inflationary pressures, having in mind the expected effects of past monetary policy tightening and taking care of the importance of economic growth continuity. The Executive Board leaves room for a future response, as appropriate given developments in the domestic and international environment, with additional monetary policy tightening, and does not exclude the possibility of considering, in addition to raising the main interest rates as a general measure, some other, more direct measures, targeting inflationary pressures.
In making the decision on further tightening of monetary conditions, the Executive Board was guided primarily by the persistently high global cost-push pressures on account of international prices of energy, primary agricultural commodities and industrial raw materials, as well as prolonged disruptions to global supply chains, which are likely to keep global inflation on an upward path for quite some time yet. The Executive Board therefore assessed it was necessary to further tighten the monetary conditions at home by raising the key policy rate, in order to limit the second-round effects on inflation expectations and make sure that inflation in Serbia strikes a downward trajectory from August. The NBS eases the spillover of rising import prices onto domestic prices to a significant degree also by maintaining relative stability of the dinar exchange rate against the euro.
Y-o-y inflation measured 10.4% in May, with food and energy prices still accounting for around two thirds. Higher imported inflation translated into a higher core inflation (headline inflation excluding the prices of food, energy, alcohol and cigarettes) which amounted to 6.3% y-o-y in May. Still, this inflation measure, affected more by monetary policy, remains considerably below headline inflation at home, but also below core inflation of regional inflation-targeting countries. In addition to preserved relative stability of the exchange rate, an important factor behind lower core inflation are medium-term inflation expectations of the financial sector, which continued to move within the NBS target tolerance band.
The Executive Board judges that inflation should return within the target tolerance band (3±1.5%) in H2 2023, on the back of past monetary tightening. The effects of government economic measures aimed at capping the prices of basic foodstuffs and energy in the domestic market will also work towards alleviating inflationary pressures in the short run. The effects of surging global prices of energy and primary commodities, as well as of higher imported inflation, are expected to gradually weaken over the projection horizon (i.e. next two years), which is consistent with the projections of relevant international institutions and market expectations. The onset of a new agricultural season has brought domestic vegetable prices in May slightly down from their hefty levels, and this is likely to continue in the coming period. Assuming an average agricultural season and lower global prices of primary agricultural commodities, going forward we should see a weakening of cost-push pressures on the production of other food in the domestic market as well.
Geopolitical developments and escalation of the Ukraine conflict reflected on upward revisions to inflation projections of a number of countries and fuelled the views about the prevalence of risks that inflation could turn out higher and more durable than initially expected, which prompted many central banks to tighten their monetary policies. In June, the Federal Reserve System continued to tighten monetary conditions by raising the federal funds rate by 75 bp points to the 1.5–1.75% range and by reducing its balance sheet, and the tightening will certainly continue in the coming period. The European Central Bank decided to wind down its asset purchase programme (APP) by the start of July, and to embark, during that month, on reference rate hikes. The NBS Executive Board judges that the tightening of monetary conditions by these leading central banks and increased uncertainty due to the deteriorated global growth outlook could instil more caution in international portfolio investors, which dictate capital flows toward emerging economies.
Despite the reduced global growth outlook for this year due to the Ukraine conflict and unfavourable economic activity indicators for the euro area in Q2 compared to Q1, Serbian manufacturing sector output and exports continued to post high growth rates in April and May, signalling that the contraction in external demand has had no major negative effects on Serbia so far. This is owed to investments in tradable sectors in previous years, which considerably boosted export supply, while the May export rise also reflected the higher exports of agricultural products after the relaxation of temporary restriction measures. Despite a high degree of uncertainty, the NBS expects further growth of our economy in the coming period, estimating that the real GDP growth this year will be between 3.5% and 4.5%. Assuming there is no further escalation of geopolitical tensions and cutoffs in global gas supply, Serbian GDP is projected to grow 4–5% per year in the medium-term.
Depending on geopolitical developments and the movement of key inflation factors in the domestic and international environment going forward, the NBS will assess whether there is a need for additional tightening of monetary conditions or whether the effects of past tightening ensure a sustainable return of inflation within the target tolerance band over the projection horizon. Delivering price and financial stability in the medium term remains the NBS’s monetary policy priority, while supporting further economic growth and development, a further rise in employment and a favourable investment environment.
The next rate setting meeting of NBs Executive Board is scheduled for 11 August 2022.