The NBU Board has decided to raise the key policy rate to 8% per annum. Given the significant increase in underlying inflationary pressures, this step is necessary to return inflation to 5% in 2022 and keep inflation expectations in check.
As anticipated, inflation in H1 2021 breached its 5% ± 1 pp target range, but the deviation, driven by both short-lived and fundamental factors, was more significant than expected.
In June 2021, consumer inflation remained at the level of the previous month (9.5% yoy), but was still higher than the NBU’s April forecast (9.2% yoy). On the one hand, this was primarily due to temporary increases in global food and energy prices. On the other hand, underlying inflationary pressures have intensified significantly. Specifically, core inflation in June accelerated to 7.3% yoy and significantly exceeded the April forecast (6.8% yoy), fueled primarily by sustained strong consumer demand and rising production costs in businesses, particularly in wages.
The rise in inflationary pressure, including its fundamental component, is also driven by the dynamic recovery of the economy, as evidenced by monthly and other high-frequency indicators. More specifically, the index of key sector output climbed by 18.3% yoy in April and by 4.1% yoy in May, while the business activity expectations index in June reached its highest level since October 2019. At the same time, favorable FX market conditions and the stabilization of inflation expectations restrained underlying inflationary pressures to some extent.
Inflation will soon rise to slightly above 10%, but it will weaken at the end of 2021 and return to its 5% target in H2 2022.
With global prices surging and demand recovering further, the NBU has revised its 2021 inflation forecast from 8% to 9.6%. After peaking in the fall of this year, inflation will begin to slow as the new harvest arrives and global energy prices adjust. By tightening its monetary policy, in particular through raising its key policy rate and rolling back its emergency monetary measures, the NBU will also keep inflation expectations under control and gradually reduce underlying inflationary pressures. As a result, inflation in H2 2022 will decline to its 5% target and remain there going forward.
The NBU has left its 2021–2023 real GDP growth forecast unchanged at about 4% a year.
Robust consumer demand and benign foreign trade conditions will make up for the losses to the Ukrainian economy due to the winter and spring lockdowns. In view of this, the NBU has maintained its 2021 real GDP growth forecast at 3.8%.
Subsequently, the economy will grow by about 4% annually. In addition to high private consumption, this growth will be driven by strong demand for Ukrainian exports, as well as a revival of investment activity by businesses.
In 2021, the current account will return to a small deficit, which will significantly expand in the years ahead as domestic demand increases and terms of trade turn less favorable.
The current account of the balance of payments will record a deficit of 0.4% of GDP in 2021. This will be due to the growth in domestic demand, the resumption of travel services imports, and higher dividend payments. These factors will only be partially offset by good terms of trade and record grain yields. In 2022–2023, the current account deficit will widen significantly as domestic demand continues to rise and terms of trade worsen.
The main assumption of the macroeconomic forecast taken into account by the NBU Board is continued cooperation with the IMF.
The NBU expects further progress to be made in negotiations between Ukraine and the IMF. Long delays in the performance of the agreement on cooperation with the IMF would create risks to financing the state budget deficit, especially in the coming years. This could also deteriorate inflation and exchange rate expectations, forcing the central bank to tighten its monetary policy.
Conversely, the performance of the IMF cooperation program would enable Ukraine to raise the planned amount of official financing, while making it cheaper to borrow on the external and domestic markets. This would also help maintain Ukraine’s international reserves at USD 29 to 31 billion in 2021 – 2023.
The key risks to the macroeconomic forecast are the imposition of stricter quarantine measures in Ukraine and globally, and a longer and more pronounced than expected surge in global inflation.
The Ukrainian economy could sustain new economic losses because of new coronavirus variants, such as the Delta variant, which are spreading rapidly across the world. That said, the NBU estimates that the negative contribution to annual real GDP of all of the quarantine restrictions that were imposed in H1 2021 was 0.6 pp. In contrast to the quarantine restrictions that were in place in the spring of 2020, the latest restrictions did not have any curbing effect on inflation, mainly due to sustained robust consumer demand.
The probability of a longer and more pronounced surge in global inflation is rising, driven by significant fiscal and monetary stimuli. This creates risks of greater imported inflation to Ukraine, and of leading central banks tightening their monetary policies more quickly. The latter development could decrease investors’ interest in the emerging markets, including Ukraine.
Other pro-inflationary risks remain important, such as an escalation of the military conflict with Russia and a sharp deterioration in terms of trade.
In view of the above balance of risks, the NBU Board has decided to raise the key policy rate to 8%, and to tighten monetary policy through some additional measures. Those measures include:
- continuing the phasing out of anti-crisis measures
- setting the interest rate on refinancing loans at the level of the key policy rate + 1 pp for fixed rate tender, and no less than this level for variable rate tender
- decreasing the planned amounts of daily interventions to purchase FX on the interbank FX market from USD 20 million to USD 5 million.
The NBU’s forecast envisages that the key policy rate will be raised further, to 8.5%, and maintained at that level until Q2 2022, with a view to bringing inflation back to its 5% target in 2022, and keeping inflation expectations in check. If additional pro-inflationary risks materialize, the NBU stands ready to continue deploying monetary tools to return inflation to its 5% target.
The decision to raise the key policy rate, to 8% was approved by NBU Board Decision on the key policy rate No.342, dated 22 July 2021.
А new detailed macroeconomic forecast will be published in the Inflation Report on 29 July 2021.
A summary of the discussion between Monetary Policy Committee members that preceded the approval of this decision will be published on 2 August 2021.
The next monetary policy meeting of the NBU Board will be held on 9 September 2021, according to the confirmed and published schedule.