The Board of the National Bank of Ukraine has decided to raise the key policy rate by 1 pp, to 7.5% per annum. This step is aimed at gradually slowing down inflation in H2 2021 and returning it to the 5% target already in H1 2022.
As expected, inflation deviated from the 5% ± 1 pp target range in Q1 2021, but the deviation was greater than forecasted, mainly due to temporary factors.
In March, consumer inflation accelerated to 8.5% yoy, while core inflation reached 5.9%. Inflation exceeded the NBU forecast published in the January 2021 Inflation Report.
On the one hand, the steep rise in inflation was largely driven by temporary factors, such as growing global prices for food and energy. A revival in the global economy and the effects of smaller harvests continued to push up prices. A low comparison base also played an important role.
On the other hand, underlying inflationary pressures increased due to sustained growth in consumer demand, which was, among other things, fueled by higher wages. Retail turnovers consistently exceeded pre-crisis levels, being 5.6% yoy larger in February. Inflation expectations remain high on the back of the rapid growth in the prices of goods consumed every day.
Considering the fast-paced recovery of the global economy and higher inflationary pressures, the NBU revised its inflation forecast from 7% to 8% in 2021, expecting inflation to return to the 5% target in H1 2022 and settle at this level further on.
Inflation will peak in Q3 2021. However, it will reverse gradually as new harvest supplies come to the market, the effect of a low comparison base wanes for some products, and the NBU raises its key policy rate. Inflation will start to decelerate in autumn, return to its target range in H1 2022, and subsequently remain there.
The Ukrainian economy is recovering, although slower than expected due to tightening of quarantine restrictions. Factoring in losses caused by the pandemic, the NBU revised downward its real GDP growth forecast for 2021, from 4.2% to 3.8%.
The economy almost reached its pre-crisis level in Q4 2020, but its recovery slowed somewhat at the start of 2021. First, the introduction of new quarantine restrictions dampened business activity. Second, last year’s smaller harvests affected the performance of agriculture, the food industry, and freight turnover. Third, increased competition in some global markets and greater trade restrictions imposed by Russia affected the industrial sector’s performance, in spite of high prices on global commodity markets. Less favorable weather conditions in January–February weakened the performance of construction and transportation. At the same time, despite the lockdowns in red zones, the real economy is expected to grow as of end-March on the back of the low comparison base and actual improvement in businesses’ performance. Taking these factors into account, the economy is projected to decline in annual terms in Q1.
The Ukrainian economy will return to steady growth starting in Q2. Consumer demand will remain the main growth driver. Investment demand will also rise gradually as the global economy revives and more progress is made in overcoming the pandemic.
However, the NBU downgraded its real GDP growth forecast for 2021 to 3.8%, down from 4.2%, mainly due to losses caused by the tightening and extension of quarantine restrictions. The Ukrainian economy will grow at a pace of around 4% in 2022–2023.
In 2021, the current account will record a slight deficit, which will widen noticeably in 2022 – 2023 on the back of rising domestic demand and less favorable terms of trade.
The current account is expected to return to a slight deficit of 0.8% of GDP in 2021, propelled by higher domestic demand and the gradual revival of international tourism. In 2022 – 2023, the current account deficit will widen noticeably, mainly due to less favorable terms of trade for exporters of agricultural and metallurgical products and the expected drop in earnings from gas transit. The deficit will also be driven by continued growth in consumer and investment imports, fueled by the complete recovery of the global and Ukrainian economies from the coronavirus crisis.
As before, the primary assumption of the NBU Board is that Ukraine will continue to cooperate with the IMF.
The NBU expects that Ukraine will make further progress in its talks with the IMF. Cooperation with the IMF and other international partners will enhance the government’s ability to support the economy during the crisis, while also helping Ukraine pass through the period of debt repayments that will peak in the coming autumn. This cooperation will help maintain Ukraine’s international reserves at a reasonably high level of USD 29 to 30 billion in 2021 – 2023.
The key risk to the macroeconomic forecast is the imposition of stricter quarantine measures in Ukraine and globally, and the slow pace of the vaccination campaign domestically.
New waves of the pandemic and new coronavirus strains forced countries to once again tighten quarantine restrictions in Q1 2021. Despite the partial adaptation of businesses to the new conditions, this is slowing the recovery of business activity. The slow pace of the vaccination campaign in Ukraine, coupled with higher inflationary pressures arising from the rebounding global economy, poses an additional risk of future economic losses.
There are other significant risks. They include:
- an escalation of the military conflict in eastern Ukraine or on the country’s borders
- volatile global capital markets and
- a dramatic deterioration in the terms of trade.
Given the above balance of risks and the increase in underlying inflationary pressures seen in recent months, the NBU Board decided to raise the key policy rate, to 7.5%.
The NBU’s baseline forecast envisages that the key policy rate will remain unchanged, at 7.5%, until the end of 2021. Given current inflationary movements, this should suffice to bring inflation back to its 5% target in H1 2022. However, if underlying inflationary pressures rise more noticeably than currently expected, and if inflation expectations worsen, there could be the need for further tighter monetary policy tightening.
The NBU stands ready to continue raising its key policy rate to a level that will bring inflation back to its 5% target in H1 2022.
The decision to increase the key policy rate, to 7.5%, was approved by an NBU Board Decision on the key policy rate No. 142, dated 15 April 2021.
A new detailed macroeconomic forecast will be published in the central bank’s Inflation Report on 22 April 2021.A summary of the discussion by Monetary Policy Committee members that preceded the approval of this decision will be published on 26 April 2021.
The next meeting of the NBU Board on monetary policy issues will be held on 17 June 2021, according to the confirmed and published schedule.