Inflation will tick up to 9.7% by the end of 2024 but will drop to 6.9% next year. It will return to the NBU’s 5% target in 2026. The economic recovery will continue, with real GDP expected to grow by 4% this year. In the next two years, economic growth will accelerate to 4.3%–4.6% per year. This scenario of the NBU's forecast is based on the assumptions that sufficient international support would be maintained and that the economy’s operating conditions would gradually normalize, which would, among other things, facilitate the return of migrants and growth in investment. The detailed analysis and macroeconomic forecast can be found in the quarterly Inflation Report of October 2024.
Inflation will continue to rise in the coming months, but will start to decline in the spring of 2025 and will continue to move toward the NBU's 5% target
The acceleration of inflation in the coming months will reflect a smaller supply of certain food products than last year, an increase in aggregate demand due to significant budget spending, a rapid growth in wages, and a widening of energy shortages during the heating season. As a result, consumer inflation will reach 9.7% by the end of 2024, and will temporarily exceed the 10% level in early 2025.
That said, inflation will start to decline in the spring of 2025. Thanks to the NBU's interest rate and exchange rate policies, as well as an increase in food supply and an easing of external price pressure, inflation will slow to 6.9% at the end of 2025. In 2026, inflation will continue to decline, reaching the 5% target as the situation in the energy sector improves and harvests increase. The NBU's interest rate and exchange rate policies will be aimed at keeping inflation expectations in check and bringing inflation to the 5% target in the coming years.
The economy is recovering faster than expected. In 2024–2026, real GDP will grow by 4%–4.6% per year
Given the stronger harvest and faster harvesting of early grain crops, smaller electricity shortages, and businesses’ better adaptation to power outages, the NBU has improved its estimate of real GDP growth for Q3 2024 from 3.1% to 4%. This led to a revision of the forecast for economic growth in 2024 from 3.7% to 4.0%. Going forward, Ukraine's real GDP growth will accelerate to 4.3% in 2025 and 4.6% in 2026. As a result, the gap between real GDP and its potential level will be minimized.
The economic recovery over the forecast horizon will be driven by the continued loose fiscal policy and a revival in domestic demand supported by rising wages, as well as by increased harvests, strong external demand for Ukrainian products, and investments in recovery, particularly in the energy sector. However, labor shortages, security risks, migration processes, and the slow normalization of economic conditions will continue to restrain economic activity.
Employment and wages will gradually increase due to a shortage of labor and stronger demand from employers
In Q3 2024, the demand for workers, as measured by the number of vacancies on job search websites, continued to increase as economic activity kept recovering. The number of vacancies in absolute terms was the highest since the start of the full-scale invasion, with growth being observed across almost all occupations. Overall, the ratio of applicants per vacancy is currently lower than in 2021. The shortage of workers on the labor market continues to fuel wage growth. Real wages are expected to grow by 14% this year. The upward trend in wages will continue in the coming years as employers compete for workers.
The unemployment rate will gradually decline as demand for labor increases, but will remain higher than before the full-scale invasion. According to the NBU's forecast, unemployment will decline to 14.2% this year, and to 11.6% and 10.6% in the next two years, respectively. Employment growth will be limited by the persistence of mismatches in the labor market due to the effects of the war, including mobilization and migration. The NBU assumes that in 2024 the number of forced migrants will rise by around 500,000 people, and next year by another 200,000 people. It is expected that the return of migrants will begin in 2026 (around 200,000 people).
International assistance will remain an important source of financing the budget deficit and accumulation of international reserves
The budget deficit will remain significant over the forecast horizon, although it will gradually narrow (from 23.3% of GDP in 2024 to 12.4% of GDP in 2026) due to the increase in internal resources amid further economic growth. Increased domestic borrowing and continued significant external financing will help cover the budget deficit. Ukraine is expected to receive USD 41.5 billion from international partners this year, and around USD 38 billion and USD 25 billion in 2025–2026, respectively.
External financing will enable the NBU to maintain a sufficient level of international reserves. By the end of 2024, they will reach USD 43.6 billion. Going forward, as international support expectedly declines, reserves will gradually go down to USD 41 billion in 2025 and USD 34.7 billion in 2026. Such levels will be sufficient for maintaining the FX market sustainability.
In addition to the updated macroeconomic forecasts, the October Inflation Report features a number of boxes
From an Exchange Rate Peg to Flexible Targeting of Inflation amid Full-Scale War
The russian full-scale invasion into Ukraine made the NBU abandon its conventional inflation-targeting (IT) format. The central bank was forced, in particular, to temporarily peg the hryvnia’s official exchange rate to the U.S. dollar and to place harsh restrictions on the FX market and on capital movements. At the same time, the NBU immediately declared its strategic intention to return to full-fledged IT as soon as the macroeconomic prerequisites allowed. Evidence from the experience of many central banks indicates that full-fledged IT is a regime that has proved effective in ensuring macrofinancial stability in the long run.
In 2022–2023, it was possible to significantly slow down inflation, shore up its role as an anchor for expectations, improve the performance of interest rate policy transmission, and largely restore the effectiveness of the key policy rate. In addition, the NBU eased the most burdensome FX restrictions and subsequently moved from the peg to managed flexibility of the exchange rate in order to strengthen its capability to absorb shocks.
By taking these steps, the NBU put in place the prerequisites for its transition to flexible IT, an intermediate monetary regime whose key parameters are set out in the Monetary Policy Guidelines for the medium term. Through the application of a consistent set of monetary instruments and due to other flexibility elements, the new regime will enable the NBU to keep the right balance between maintaining the controllability of inflationary processes and facilitating the Ukrainian economy’s adjustment to war shocks, as well as supporting its recovery going forward.
In Search of Optimal Flexibility: The Quantitative Inflation Target and the Monetary Policy Horizon
Central banks that target inflation pursue the mandate of ensuring price stability. To fulfill this mandate, they announce a clear-cut quantitative target for inflation and articulate a commitment to eliminate actual inflation’s deviations from the target within a specific time period – the policy horizon. Success in achieving the inflation target makes up a fair part of central banks’ credibility, a vital prerequisite for anchoring expectations and a guarantee that sustains macrofinancial stability in the long term.
Global experience shows that elevated economic uncertainty may require the central bank to temporarily adjust the type of the quantitative inflation target and extend the policy horizon to make the response to macroeconomic turbulence more flexible and the economy more resilient. However, the policy horizon should not be so protracted that it calls into question the central bank’s desire or ability to ensure price stability.
Given the war’s unprecedented challenges and the uncertainty surrounding it, the NBU’s monetary policy has to be flexible and at the same time transparent and predictable. With this in mind, the NBU switched to a flexible-inflation-targeting regime that focuses monetary policy on bringing inflation to the 5% target, as was the case before the full-scale invasion. The NBU also abandoned the range of acceptable one-percentage-point two-way deviations from the target and extended the maximum duration of the policy horizon from 18 months to three years.
In Search of Optimal Flexibility: What Is an Acceptable Deviation of Inflation from the Target?
The desire of central banks to avoid all deviations of inflation from the target, even in the short run, may be ineffective and at times counterproductive. On the other hand, a rapid and prolonged acceleration in inflation significantly increases the risk of a loss of confidence in the central bank, as well as the threat of an unanchoring of inflation expectations, with adverse consequences for macrofinancial stability and economic growth.
In practice, this prompts inflation-targeting central banks to pursue a flexible, non-linear monetary policy in search of a compromise between maintaining the economy’s resilience to shocks and ensuring price stability over the medium term. To this end, in some short-term periods, a central bank may refrain from tightening its monetary policy, allowing inflation to stray moderately from the target. However, central banks should respond in a timely and decisive manner to the risk of inflation remaining above the threshold for a long time, to avoid excessive threats to price stability. Multiple studies have shown that a consistent and sufficiently strict monetary policy not only prevents inflation from being stuck at high levels, but also reduces the risk of recurrent spikes in prices and makes it possible to hold back the weakening of the domestic currency and the growth in production costs. Short-term losses to the economy from such policies are fully offset in the medium term.
That is why the NBU aims to maintain moderate inflation even in wartime and prevent it from remaining in the double digits for long. To rein in price pressures, the NBU in mid-2024 suspended its cycle of key policy rate cuts and made efforts to preserve the sustainability of the FX market. If pro-inflationary risks continue to materialize, the NBU stands ready to deploy all available monetary policy tools.
Restoring Sufficient Effectiveness of the Key Policy Rate as a Prerequisite for the Transition to Flexible Inflation Targeting
In June 2022, when economic agents had partially adjusted to the shock from the war, the NBU resumed its active interest rate policy, using the key policy rate as an auxiliary tool to subdue the pressure on the exchange rate and international reserves. With the full-scale war grinding on, however, the response of rates on some of the hryvnia instruments to changes in the NBU’s key policy rate comes with specific features that differ from those of the typical response.
In this regard, the NBU in 2023 took a set of additional measures to incentivize banks to compete for hryvnia retail term deposits and – after the shift to a policy-easing cycle – constrain, in a targeted manner, the decline in deposit rates so that hryvnia savings would be adequately protected from losing value to inflation. The transmission of the NBU’s monetary decisions to the yield on hryvnia domestic government debt securities gradually improved, thanks in part to better coordination, with Ukraine’s Ministry of Finance, of efforts to activate the domestic debt market. Preservation of macrofinancial stability, in its turn, contributed to the gradual revival of market-based lending to businesses, boosting the speed and power of transmission to rates on business loans.
As a result, the effectiveness and predictability of the key policy rate’s impact on market rates increased over time. This is still not enough for the key policy rate to fully perform its role as the main monetary instrument. However, combined with other monetary instruments, the strengthening of the key policy rate’s role made it possible to transition to flexible IT, in line with the NBU’s strategic priorities.