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Serbia Monetary Policy July 2019

Serbia: NBS unexpectedly slashes key policy rate in July

At its 11 July monetary policy meeting, the executive board of the National Bank of Serbia (NBS) voted to cut the key policy rate to a new record low of 2.75% from 3.00%, where it had been for over one year. The Bank’s decision was unexpected by the majority of FocusEconomics panelists, who had penciled in the NBS to hold fire until the end of the year. The Bank’s decision was primarily guided by the appreciation of the dinar alongside a shifting international environment.

The dinar has appreciated notably against the euro this year, requiring the Bank to intervene in foreign exchange markets to keep the currency stable. The stronger dinar has in part fed through to softer inflation, which eased to 2.2% in May, falling below the midpoint of the Bank’s tolerance band of 3.0% plus or minus 1.5 percentage points. Meanwhile, the NBS continues to expect inflation to remain in-target for this year and next.

ING economists, who had penciled in a rate cut later in the third quarter, had reasoned prior to the meeting that the Bank’s increased intervention in foreign exchange markets could be a main determinant for the Bank to shift its policy stance, noting:

“As the currency is almost at a five-year high against the euro, the NBS had to ramp-up its interventions to new historical highs: €735 million were bought in June to keep the EUR/RSD close to the 118.00 level. For now, it looks that the central bank is happy to expand its FX reserves and keep the exchange rate stable, but should the inflows (predominantly bond related) continue, a rate cut will likely be seriously considered in the near term.”

Notably, the recent shift in tone of major economies’ central banks also cleared the way for the NBS to take a more accommodative stance. The NBS referenced dovish swerves from both the ECB, which announced a string of accommodative measures and signaled that it would hold interest rates through mid-2020, as well as the U.S. Federal Reserve, which is now expected to cut the federal funds rate sometime this year. Consequently, monetary easing by key economies would likely improve financial conditions for emerging markets such as Serbia, which would boost capital inflows in turn.

The Bank’s communiqué was void of forward guidance as to whether this is the start of a round of monetary policy loosening or a one-off easing. It was, however, notably less cautious, dropping its reference to “persistent uncertainty in the international environment” and mention of risks from trade tensions and oil prices. Moreover, while the Bank still alluded to a global growth slowdown, the NBS remained upbeat about Serbia’s increased resilience to external shocks and adequate coverage of the current account deficit in FDI inflows.

The next monetary policy meeting will be held on 8 August.

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