The Board of the National Bank of Ukraine has decided to raise the key policy rate to 8.5% per annum. In addition, the NBU will stop applying its anti-crisis monetary measures at the start of Q4.
Tighter monetary policy will help rein in inflation expectations and bring back a steady disinflation trend toward the 5% target, which is projected to be met in 2022.
Inflation has been exceeding 10% in the last several months, influenced by both temporary and fundamental factors. Still, it remains close to the forecast trajectory.
In July 2021, consumer prices grew by 10.2% yoy, which was in line with the latest macroeconomic forecast (July 2021 Inflation Report). Inflation continued to accelerate in August, according to the NBU’s preliminary estimates.
Despite a correction of prices for some foods and a gradual weakening of the low comparison base effect, sustained high global prices for energy and food made a large contribution to headline inflation. Unfavorable weather in July–August also impacted domestic prices of some food products.
Underlying inflationary pressures are also persisting. Current estimates by the State Statistics Service of Ukraine show that GDP growth in Q2 2021 (5.4% yoy) was below the NBU forecast (7.5% yoy), mainly due to temporary and technical factors. At the same time, the economy has been recovering quickly in Q3, thanks to large harvests, favorable external environment, sustained consumer demand, and revived investment activity. Taking into account the economic recovery, an increase in migration pressures, and the impact of structural factors, wages continue to grow at a fast pace. The rapid growth in real household income supports domestic demand. This is evidenced, among other things, by a pickup in retail trade and high demand for durable goods.
Inflation expectations remain high. They have deteriorated slightly since the previous NBU Board meeting on monetary policy issues. The risk remains that inflation expectations will keep de-anchoring.
At the same time, core inflation has stabilized over last months, particularly thanks to a correction of sunflower oil prices and the stronger hryvnia. The strengthening of the hryvnia was driven by the benign external environment for Ukrainian exporters and the NBU’s prudent monetary policy.
Inflation will slow at the end of this year and gradually return to the 5% target in 2022.
The NBU expects inflation to remain within the range of 10%–11% in September–October and decline below 10% in the last months of the year. Inflation will continue to slow next year: it will gradually return to the target of 5%.
The waning effect of last year’s low comparison base, a correction of global commodity prices, and new, larger harvests of agricultural crops coming to the market will contribute to the decline in inflation. The NBU tightening its monetary policy will also restrain the price growth.
As before, the primary assumption of the NBU Board is that Ukraine will continue to cooperate with the IMF.
The disbursement of USD 2.7 billion to Ukraine as part of an SDR allocation by the IMF helped finance Ukraine’s short-term budget needs, including external debt repayments. At the same time, to maintain its macrofinancial stability in the coming years, Ukraine must continue to cooperate with the IMF under the stand-by program.
The implementation of the IMF program will ensure access to official funding from other sources, contribute to lower interest rates on external borrowing, and support foreign investors’ appetite for hryvnia assets.
At this time, major risks to the economy are the potential imposition of much tighter quarantine measures in Ukraine and globally, and a longer and stronger-than-expected surge in global inflation.
The spread of new variants of COVID-19 may lead to another tightening of quarantine restrictions and a weakening of economic activity. The direction of the impact on inflation will be determined by the ratio between proinflationary factors (due to production chain disruptions) and disinflationary factors (driven by a weaker aggregate demand).
A longer-than-expected price surge in commodity markets and Ukraine’s MTPs will put pressure on domestic prices and pose the risk of a longer-term deviation of inflation from its 5% target.
Other proinflationary risks continue to loom large. Those include an escalation of Russian military aggression against Ukraine and a sharp worsening of terms of trade.
Given the balance of risks, and considering how close the actual dynamics of macro indicators are to the current forecast, the NBU Board decided to raise its key policy rate to 8.5%. This decision corresponds to the projected trajectory of the key policy rate (see the July 2021 Inflation Report).
In addition, as previously reported, the NBU approved the rollback of its emergency monetary measures, specifically the termination of long-term refinancing tenders and interest rate swap auctions, starting in Q4 2021.
To boost the efficiency of monetary transmission, the NBU also continued to normalize the design of its monetary policy. From 1 October, the maturity of refinancing loans is reduced to 30 days from 90 days.
If underlying inflationary pressures increase significantly and inflation expectations continue to worsen, the NBU stands ready to take additional measures to return inflation to its 5% target.
Effective 10 September 2021, the increase in the key policy rate to 8.5% was approved by NBU Board’s Key Policy Rate Decision No. 461 dated 9 September 2021.
A summary of the discussion between Monetary Policy Committee members that preceded the approval of the NBU Board’s decision will be published on 20 August 2021.
The next meeting of the NBU Board on monetary policy issues will be held on 21 October 2021 as scheduled.