Serbia Surprises With Rate Cut Despite Brexit Uncertainty

(Bloomberg) -- Serbia's central bank unexpectedly cut its benchmark rate to a record, leveraging support from a strong dinar to attack below-target inflation as emerging Europe grapples with the fallout of the U.K.'s vote to leave the European Union.

The National Bank of Serbia cut its one-week repurchase rate to 4 percent from 4.25 percent on Thursday, according to a statement on its website. The decision was predicted by only two of 24 economists surveyed by Bloomberg, with twenty-two forecasting no change. The bank also narrowed the corridor between the deposit and lending rates to plus/minus 1.5 percent, from 1.75 percent.

“Weak inflationary pressures will remain in the coming period, based on most domestic factors,” the bank said in the statement. “The cut in the benchmark rate to 4 percent will ensure that inflation returns to the target band next year.”

The cut overruled concerns over the Brexit vote, which has rattled assets across emerging Europe. It also brushed aside Prime Minister Aleksandar Vucic's protracted deliberations on forming a new government. While Vucic won a majority in April snap elections, he has yet to form a cabinet and start making good on a plan to trim the budget deficit and debt and shut down or sell state companies that drain more than $1 billion from public coffers each year.

Shifting Focus

Instead, by enacting the first cut since February, rate setters resumed a string of 16 reductions that started marching the cost of borrowing lower from 11.75 percent in 2013. Thursday's statement by the bank departed from its comments in June, when it said its level of monetary expansiveness was sufficient to lead inflation back toward the 2.5 percent to 5.5 percent target band. Prices grew 0.7 percent in May compared with a year earlier.

“We find the decision was not quite in line with the previous statement, given that the rate was kept intact on the last four meetings on the grounds of higher external risks and expectation of steady inflation growth in H2,” analysts at Raiffeisenbank in Belgrade said in a note to investors. “Our current forecast suggests that this is the last rate cut this year.”

The dinar brushed off the decision, trading little changed at 123.54 against the euro at 2:47 p.m. in Belgrade. The yield on Serbia's dollar bonds maturing in 2021 rose three basis points to 3.981 percent, after declining below 4 percent for the first time on Wednesday. The dinar has gained 0.1 percent against the euro since the Brexit vote. 

Investors Depart

The government expects economic growth this year of at least 2.5 percent, while good wheat and maize harvests may push the headline growth number to as high as 2.8 percent, according to Vucic.

That hasn't stopped investors from pulling about 1.7 billion euros ($1.9 billion) from Serbia this year, according to central bank Governor Jorgovanka Tabakovic, and the monetary authority has sold euros on the market to smooth the fluctuations in the currency. One measure that may help boost investor confidence would be the instillation of a new government, said Liljana Grubic, an analyst at Raiffeisenbank in Belgrade.

“Investors have been holding back because of Brexit and because Serbia has not yet formed a new government,” she said.

To contact the reporter on this story: Gordana Filipovic in Belgrade at gfilipovic@bloomberg.net. To contact the editors responsible for this story: James M. Gomez at jagomez@bloomberg.net, Michael Winfrey