The Board of the National Bank of Ukraine has decided to keep its key policy rate at 8.5% per annum. This decision comes in line with a decline in inflation to 5% at the end of next year projected in the baseline scenario of the updated macroeconomic forecast.
As expected, inflation ranged between 10% and 11% in the past several months, which was close to the forecast the NBU made in July.
Consumer inflation increased to 11% in September. A number of external and internal factors continued to fuel inflation. Global commodity prices remained high. The underlying inflationary pressure also persisted as expected. An increase in businesses’ production costs – namely expenses on wages, raw materials, and energy – impacted consumer prices. Inflation expectations also remained high.
At the same time, benign FX market conditions restrained price growth. This maintained core inflation below the July forecast trajectory.
Inflation will decline to a single-digit level at the end of 2021 and will reach the 5% target at the end of 2022.
The NBU has maintained its 2021 inflation forecast at 9.6%. The NBU estimates the growth in consumer prices will peak in September–October this year. Afterwards, the inflation trend will reverse. Inflation will decline thanks to waning low base effects, FX markets remaining favorable, and this year’s large harvests. The monetary policy tightening actions taken earlier by the NBU – the optimization of the monetary policy design, a complete phaseout of anti-crisis monetary measures, and raising the key policy rate – will also curb growth in consumer prices.
The above factors will make inflation slow to 5% at the end of 2022 and remain close to the target further on. A faster disinflation will be impeded by energy prices remaining high longer and by sustained consumer demand. Moreover, considering the prolonged effects of these pro-inflationary factors, the NBU will have to tighten the monetary conditions in 2022–2023 more than envisaged in the July forecast in order to bring inflation to the target of 5%.
The NBU has revised its forecast of real GDP growth over the forecast horizon taking into account a more lasting and strong impact of the pandemic and the consequences of the surge in natural gas prices.
In H1 2021, the economic recovery was somewhat weaker than expected. This was driven by a number of factors, in particular by quarantine restrictions. In contrast, high-frequency indicators of economic activity point to an economic revival in H2. A record harvest of early grain crops spurred growth in agriculture. Robust consumer demand supported retail trading and passenger turnovers. A pickup in investment activity, together with a favorable external price environment, contributed to a recovery in construction and industrial production. However, factoring in the results of H1, high energy prices, and the worsening of the pandemic, the NBU has revised downward its economic growth forecast for 2021, from 3.8% to 3.1%.
Unfavorable conditions on the energy market and the impact of global logistic problems will continue to limit Ukraine’s industrial output and curb economic recovery next year. Therefore, the NBU has downgraded its GDP growth forecast for 2022, from 4% to 3.8%. The economy will grow by 4% in 2023.
The main drivers of economic growth over the forecast horizon will be the continued global economic recovery and an increase in domestic demand, including investment demand. The terms of trade will also remain favorable for Ukrainian exporters. The progress in vaccinations will have a positive effect as well, as it will prevent the imposition of lockdowns or other restrictions on economic activity. In particular, this will let the services sector recover and will help bring the labor force participation rate to its pre-pandemic levels.
The current account deficit will be small in 2021 on the back of a bumper harvest and high export prices. However, it will widen markedly in the coming years.
In 2021, the current account deficit will hit about 1% of GDP. In the coming years, the deficit will gradually widen to 3% to 4% of GDP. The deficit will be driven by some worsening in the terms of trade and more robust consumer and investment demand resulting from economic recovery. The current account deficit will be fully offset by inflows of capital – both debt and foreign direct investment inflows – in Ukraine.
The main assumption made by the NBU Board is that Ukraine will continue to cooperate with the IMF.
Ukraine has reached staff level agreement (SLA) with the IMF. This has opened the way for the first revision of the Stand-by Arrangement (SBA) by the IMF Executive Board, and for consideration of the request for the program to be continued. The implementation of the existing Stand-by Arrangement will ensure the receipt of official financing in 2021–2022, provide better terms of external borrowing, while also supporting foreign investors’ interest in hryvnia assets. Cooperation with the IMF will help speed up economic growth, stabilize inflation at its target level, and maintain international reserves at USD 30 to USD 31 billion in the coming years.
As set forth in the baseline scenario, with a view to bringing inflation back to its 5% target, the NBU will keep its key policy rate no lower than 8.5% at least until Q3 2022 rather than until Q2, as was expected in July.
The key policy rate will be cut more gradually in 2022 than forecast before. The key policy rate is also expected to stand at 7.5% in late 2022, as opposed to 6.5%, as predicted in the previous forecast.
The key risks to the economy are the imposition of stricter quarantine measures in Ukraine and globally, and a longer and more pronounced than expected surge in global inflation.
Higher morbidity due to the low vaccination coverage in Ukraine could lead to a stricter lockdown and a more significant slowdown in economic activity. However, in contrast to the quarantine imposed last year, this time supply will be more affected than demand, which could increase pro-inflationary pressures.
What is more, there are stronger risks of a more protracted global price surge than envisaged in the baseline scenario, which will put pressure on domestic prices. This, among things, refers to high energy prices persisting for a long time and disrupted supply chains amid strong aggregate demand. These factors could cause global stagflation.
Other pro-inflationary risks also remain important, such as a sharp deterioration in terms of trade, capital outflows from emerging markets, and an escalation of the military conflict with Russia.
In view of the above, the NBU assesses the balance of risks for its baseline scenario of inflation and the key policy rate as having shifted upwards, especially in the medium term.
If the said or any other pro-inflationary risks materialize, the NBU stands ready to raise its key policy rate and deploy other monetary tools. It could decide to do so even during the December meeting.
The decision to keep the key policy rate at 8.5% was approved by NBU Board Decision on the key policy rate No. 517, dated 21 October 2021.
A new detailed macroeconomic forecast will be published in the central bank’s Inflation Report on 28 October 2021.
A summary of the discussion by Monetary Policy Committee members that preceded the approval of this decision will be published on 1 November 2021.
The next monetary policy meeting of the NBU Board will be held on 9 December 2021, according to the confirmed and published schedule.