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NBU Leaves Its Key Policy Rate Unchanged at 6%

NBU Leaves Its Key Policy Rate Unchanged at 6%

The Board of the National Bank of Ukraine has decided to keep its key policy rate at 6% per annum. The NBU continues to deliver on its commitment to reach the inflation target. Further on, the central bank will aim its monetary policy at striking the right balance between responding to inflation risks and supporting economic recovery.

In 2020, inflation accelerated to 5%, reaching the midpoint of the target range

During most of last year, inflation was below the 5% ± 1 pp target range. Falling global energy prices, as well as declining demand for non-staple goods and services, restrained price growth during the pandemic. At the same time, inflation increased expectedly at the end of the year. This was due to the rapid global economy recovery, the further strengthening of domestic consumer demand, and increases in prices for energy and certain foods. As a result, inflation in December returned to the target range.

Inflation will accelerate in H1 2021, but will return to the 5% ± 1 pp target range in H1 2022

The NBU has revised upwards its forecast for inflation in 2021 from 6.5% to 7%. Inflation will accelerate in H1 on the back of strong consumer demand, higher energy prices, and last year’s lower harvests of agricultural crops. In addition, businesses will face higher production costs, in particular labor costs. Administered prices will continue to grow rapidly due to increases in electricity rates and excise taxes on tobacco products.

Throughout the second half of the year, the impact of pro-inflationary factors will weaken, which will reverse the inflation pattern. Food price inflation will decelerate thanks to an increase in supply of newly-harvested agricultural products, and the effect of low comparison base will vanish for some goods at the end of the year. The NBU’s monetary policy will also be aimed at reducing underlying pressures on prices due to robust consumer demand and at improving inflation expectations. As a result, it is expected that core inflation will be 5.9% at the end of 2021, and headline inflation will return to the target range in H1 2022. In 2022–2023, inflation will hover around the medium-term target of 5%.

The economy contracted much less than expected in 2020. It will grow at the rate of around 4% in 2021 and the following years

The NBU estimates real GDP to decline by 4.4% in 2020, which is less than expected in the previous forecast (6%). The Ukrainian economy recovered rather quickly in H2. After the strict lockdown ended, the decline in GDP slowed to 3.5% yoy in Q3 and continued to decelerate in Q4. The tightening of quarantine restrictions in November had a minor impact on business activity.

The rapid economic recovery was mainly driven by growth in domestic consumption. Increased household incomes and budget spending are keeping consumption high. Retail trade continued to grow rapidly in Q4. GDP dynamics were also improved by higher current budget expenditures on infrastructure, especially on road repairs, and on healthcare. On the other hand, companies’ investment activity remained sluggish.

In 2021, the economy will almost recover from the losses inflicted by the coronavirus crisis: Ukraine’s GDP will rise by 4.2% and will continue to grow rapidly at around 4% in 2022–2023. Strong domestic demand will remain the main economic growth driver, underpinned by further increases in real household income. Lower uncertainty about the course of the pandemic will favor a recovery in investment activity.

Having recorded a large surplus last year, the current account of the balance of payments will go into deficit again in 2021–2023

The surplus of Ukraine’s current account is expected to hit one of its record-high levels, reaching 4.8% of GDP.

In 2021–2023, however, the current account will return to deficit. Although the prices of, and external demand for, Ukraine’s main exports will remain rather high, terms of trade will deteriorate due to rising energy prices. The economic recovery will also be accompanied by a gradual increase in investment imports. Consumer imports will continue to rise steadily, driven by the expected increase in household income.

The primary assumption, underlying the NBU Board considerations, is that Ukraine will continue to cooperate with the IMF

In 2021, Ukraine expects to receive IMF financing under the current Stand-by Arrangement, as well as official financing from the EU, the World Bank, and other international partners. These funds will enable the country to finance a significant portion of the budget in 2021.

Cooperation with the IMF remains an important signal for international investors. It will noticeably ease the government’s access to the international markets, while also decreasing the cost of planned borrowing. Financing by the IMF and other international partners will enable Ukraine to maintain its international reserves at about USD 30 billion, despite making large repayments of external debt.

The main risks to this forecast are a rise in coronavirus cases both in Ukraine and globally, and a larger inflow of foreign debt

Worldwide vaccination is reducing the risk of repeated lockdowns. However, given the slowness of the vaccination process and the emergence of new virus strains, there is a possibility of local quarantines, which will have negative consequences for economic activity. That said, extremely loose global monetary conditions and the optimism about vaccinations have significantly boosted the interest of foreign investors in emerging markets, including Ukraine. Large capital inflows could lower inflationary pressures through the exchange rate channel.

Other risks also remain significant. They include:

  • an escalation of the military conflict in eastern Ukraine or on the country’s borders, and
  • higher inflationary pressures arising from trading partners
  • higher volatility of global food prices, driven by global climate change and stronger protectionist measures worldwide.

Given the current balance of risks, mostly temporary pro-inflationary factors, weak investment activity, and businesses’ depressed sentiment amid the imposition of tighter quarantine measures, the NBU Board decided to keep the key policy rate unchanged in January 2021, at 6%.

The NBU stands ready to raise its key policy rate in future to bring inflation back to its target

The NBU takes into account the worsening of inflation expectations that occurred in late 2020, as well as stronger underlying pressures on prices arising from consumer demand. If the impact of these factors continues to increase and is not offset by other factors, such as a large capital inflow, the NBU will raise its key policy rate. This will enable the central bank to curb the rise in inflation in 2021 and bring inflation back to its target in 2022.

A new detailed macroeconomic forecast will be published in the central bank’s Inflation Report on 28 January 2021.

A summary of the discussion by Monetary Policy Committee members that preceded the approval of this decision will be published on 1 February 2021.

The decision to keep the key policy rate at 6%, was approved by an NBU Board Decision on the key policy rate – № 16-rsh dated 21 January 2021.

The next monetary policy meeting of the NBU Board will be held on 4 March 2021, according to the confirmed and published schedule.

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