The Board of the National Bank of Ukraine has decided to raise the key policy rate to 9% per annum. The decision is aimed at neutralizing the impact of additional pro-inflationary risks, improving inflation expectations, and ensuring steady disinflation toward the target of 5%.
The inflation surge has passed its peak, but inflation is declining slower than expected
The growth in consumer prices decelerated to 10.9% yoy in October. The NBU estimates inflation continued to slow in November. This was supported by the vanished effect of the last year’s low comparison base, better harvests gathered this year, administrative decisions on public utility rates, and the impact of previous decisions to tighten the monetary policy. Effects of the current weakening of the hryvnia against the U.S. dollar are partially offset by the hryvnia’s strengthening against the currencies of Ukraine’s other major trading partners.
However, disinflation is slow due to a number of factors. In particular, second-round effects from rises in food and energy prices put higher pressures on prices of an increasingly wider list of consumer-basket goods and services. Inflation is also fueled by businesses’ higher expenses on logistics and wages. In addition, domestic consumer demand remains robust despite a slight deterioration in consumer confidence and quarantine restrictions. As a result, the current inflation trajectory remains higher than expected in the October macroeconomic forecast of the NBU.
Additional pro-inflationary risks are also materializing. Rising geopolitical tensions are affecting prices of Ukrainian assets and FX market conditions. Considering the current situation, global natural gas and food prices are likely going to be higher than expected. Global inflation continues to accelerate, prompting leading central banks to step up their monetary policy tightening. In turn, this lowers investor interest in assets of emerging markets.
Inflation will continue to decline gradually at the end of this year and throughout the entire 2022
Food inflation will decelerate due to both large harvests gathered this year and a correction of global prices in 2022. Natural gas prices in Europe are also expected to go down in spring, after the heating season is over. The underlying pressure will also ease gradually in view of the expected slower growth in wages next year and the sustained effect of monetary policy tightening by the NBU.
Progress achieved in cooperation with the IMF is a key factor for reducing uncertainty
In late November, the IMF Executive Board made a decision to give Ukraine a second tranche of about USD 700 million (in the equivalent) under the current stand-by arrangement, while also extending the arrangement. Continued cooperation with the IMF and other official lenders will help the government carry out key reforms and facilitate the rapid recovery of the Ukrainian economy from the coronavirus crisis.
Key risks to the economy are posed by an escalation of the military conflict with Russia and a longer global price surge than expected earlier
Considerable uncertainty over whether or not the military conflict will escalate could worsen expectations, in particular inflation expectations, and cause investors to put off their investment decisions, which would dampen economic recovery.
A related geopolitical risk arises from high gas prices persisting longer than envisaged in the forecast. The risk of a further increase in global food prices also remains important. Through second-round effects, these factors could push up prices for an increasingly larger number of goods and services.
Prolonged and higher global inflation, especially a surge in inflation in central and eastern Europe, could also put pressures on domestic prices in Ukraine. A faster-than-expected monetary response by leading central banks poses the risk of there being capital outflows from emerging markets.
The economic repercussions arising from the spread of new coronavirus variants are creating a lot of uncertainty. However, these repercussions could increase the risk of global stagflation on the back of logistic and production problems.
The NBU continues to assess the balance of risks for its baseline scenario of inflation and the key policy rate as having tilted to the upside.
With a view to offsetting the impact of several pro-inflationary factors that have materialized since the last monetary policy meeting and that could prevent inflation from decelerating to its target, the NBU Board decided to raise the key policy rate to 9% per annum.
If pro-inflationary factors continue to materialize, the NBU stands ready to raise its key policy rate at the next Board meetings on monetary policy issues
The decision to raise the key policy rate, to 9% was approved by NBU Board Decision on the key policy rate No. 608, dated 9 December 2021.
A summary of the discussion between Monetary Policy Committee members that preceded the approval of this decision will be published on 20 December 2021.
The next meeting of the NBU Board on monetary policy issues will be held on 20 January 2022, according to the confirmed and published schedule.