The NBU Board has decided to cut the key policy rate to 17.5% per annum effective 26 April 2019. Inflation declining steadily towards the target of 5% allows the National Bank of Ukraine to start the cycle of key policy rate cuts. At the same time, the NBU Board sees risks that may hinder these plans.
In March 2019, annual consumer price inflation continued to slow and reached 8.6%, which was in line with the NBU’s latest forecast. Core inflation declined even faster than expected (to 7.6%). This evidenced that underlying inflationary pressures continued to weaken in early 2019.
The decline in inflation was supported by the NBU’s tight monetary policy, which was one of the reasons for the strengthening of the hryvnia. This impacted the prices of imported goods and goods that have a substantial import content. Despite the electoral events, the situation on the Ukrainian financial market remains benign and inflation expectations continue to improve among households, businesses, banks, and financial analysts.
In addition to monetary factors, an increase in the domestic supply of some food products and lower global food prices also dampened inflationary pressures.
Inflation will continue to decline gradually
The NBU reiterates that inflation will decline to 6.3% at year-end 2019 and reach 5.0% at the end of 2020. Inflation will enter the target range of 5% +/- 1 pp already in early 2020, in line with the forecast. This will be the result of tight monetary conditions and restrained fiscal policy.
The major factors behind the further decline in inflation also include:
- slower growth in wages, which are gradually converging with wages in neighboring countries, as a result of weaker migration processes
- appreciation of the hryvnia in Q1 2019, which will limit growth in prices for nonfood goods
- lower global prices for natural gas that will pass through to domestic prices
- larger supply of both domestic and imported food products.
These factors will also contribute to the continued slowdown of core inflation to 5.0% this year and 3.7% in the subsequent year.
The expected increase in some tariffs to the market levels and higher excise taxes on alcoholic and tobacco products will restrain the decline in inflation.
Economic growth will slow in 2019 to rebound in 2020
As well as in January, the NBU forecasts a slowdown in economic growth to 2.5%. This will be due to a slowdown in the global economy and trade, restrained fiscal policy resulting from the need to repay large volumes of public debt, and tight monetary conditions required to bring inflation to its target. Moreover, the harvest of grains and oil crops is expected to be lower compared to the bumper crop of 2018.
Private consumption will remain the main driver of economic growth. However, its growth will decelerate due to a slower growth in real household income – wages, pensions, and remittances from abroad. Investment demand will be limited by political uncertainty in the year of presidential and parliamentary elections.
Growth in real GDP will accelerate to 2.9% in 2020 and 3.7% in 2021. The growth will be propelled by a gradual easing of monetary policy, which will bolster domestic demand, and spur investment activity as the election cycle is over. Economic growth will be restrained by decreased volumes of natural gas transit to Europe as a result of the construction of bypass pipelines.
In 2019, the current account deficit is projected to stay at the previous year’s level, at 3.3% of GDP, due to various factors. Proceeds from selling the last year’s record harvest of corn and the effect of favorable trade conditions will be offset as economies of Ukraine’s main trading partners cool. This will affect exports and the amount remittances from labor migrants. In future, the current account deficit will widen slightly, to reach 4% of GDP in 2021, as a result of a decrease in natural gas transit and weak demand from the main trading partners caused by stronger investment demand on domestic markets.
The continued fulfillment of Ukraine’s obligations under cooperation program with the International Monetary Fund remains the basic assumption of the macroeconomic forecast
This will allow Ukraine to attract other official financing, improve the conditions of access to international capital markets, and support active interest of nonresidents in hryvnia-denominated domestic government bonds. These borrowings will make it possible for the government to repay external public debt, the repayments of which will peak in 2019–2020. Inflows of debt capital and investments to the private sector will continue as well.
As a result, international reserves will hover around USD 21–22 billion during this and subsequent years.
The usual increase in uncertainty during presidential and parliamentary elections poses the main internal risk to the said macroeconomic forecast (in particular, to inflation declining to the target in 2020). The NBU will consider this risk in its monetary decisions mainly due to its impact on the financial market and inflation expectations.
The following external risks are also important:
- the global recession and lower raw commodity prices
- stronger geopolitical tensions, particularly due to the uncertainty around Brexit
- uncertainty over the volume of gas transit through Ukraine starting in 2020, as pipelines bypassing the country are being built to deliver gas to Europe
- an escalation of the military conflict and new trade restrictions introduced by Russia.
Considering the revised macroeconomic forecast and the balance of risks, the NBU Board has decided to lower its key policy rate to 17.5%.
As it initiates an easing cycle, the NBU Board points out that the further steps will depend on the realization of inflation risks and an improvement in inflation expectations
However, despite that there are macroeconomic preconditions for the cycle of key policy rate cuts, this process might be impeded by materialization of risks to financial stability (mentioned in the statement of the Financial Stability Council last week) and to the central bank`s independence. The NBU will closely monitor the developments in Ukraine and, in case such risks materialize, is ready to react using monetary instruments.
The decision to cut the key policy rate to 17.5% is approved by NBU Board Decision No.311-D On the Key Policy Rate dated 25 April 2019.
A new detailed macroeconomic forecast will be published in the Inflation Report on 3 May 2019.
A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 6 May 2019.
The next meeting of the NBU Board on monetary policy issues will be held on 6 June 2019 as scheduled.