Inflation will have declined to 6.3% by year’s end and will reach the target range of 5% ± 1 pp in early 2020 and the medium-term target of 5% in late 2020, the NBU estimates. Ukraine’s economy will grow steadily in 2019–2021, at a projected annual rate of 3%–4%. For details, see the NBU’s quarterly Inflation Report dated July 2019.
The NBU has left the inflation forecast unchanged from the projection it made in April. The rather tight monetary conditions will continue to contribute to the decrease in inflation. Even if the NBU gradually reduces the key policy rate to a neutral 8% in nominal terms in 2021, its real value will remain high during 2019–2021 on the back of improved inflation expectations. Other factors that will drive the decline in inflation include prudent fiscal policy, slower growth in wages, relatively low global energy prices, and an ample supply of food products.
The NBU has increased its economic growth forecast for 2019 (to 3% from 2.5%) and for 2020 (to 3.2% from 2.9%). This is due to the more stable domestic demand, better terms of trade, and the expected increase in grain harvest. An easing of monetary policy and an upturn in global economic activity will help accelerate economic growth in 2020–2021 (to 3.2% and 3.7%, respectively).
In addition to the updated macroeconomic outlook, the July 2019 Inflation Report features a number of special topics, including the following:
- Publication of the Key Policy Rate Forecast
The NBU has started publishing a regular forecast of its key policy rate as part of its macroeconomic outlook. International experience shows that this will increase the clarity and predictability of monetary policy for market participants, improve the effectiveness of the key policy rate’s impact on market interest rates and inflation, and reduce the risk premium.
At the same time, this forecast does not obligate the NBU to follow the published trajectory. In making decisions on the key policy rate, the NBU Board may deviate from the forecast in order to account for changes in the assessment of risks to the NBU’s ability to achieve its targets, primarily inflation targets, and to take into account the emergence of internal and external factors that the NBU has not factored into its baseline scenario.
- Monetary Policy in Emerging Markets as Trade Standoffs Escalate
The escalation of the trade conflict between the United States and China led to a contraction in investment activity and trade in H1 2019. This has negatively affected the growth prospects of the global economy and price dynamics in global commodity markets.
At the same time, these factors have significantly mitigated the Fed’s and ECB's rhetoric. In turn, the easing of global financial conditions has supported investor interest in risky assets. However, the risks of exacerbating conflicts persist, so most emerging markets may simultaneously face a drop in aggregate demand and a rise in depreciation pressure.
The risks associated with deepening trade wars, the global economic slowdown, and the decline in commodity prices bear relevance for Ukraine.
- Households’ Inflation Expectations
Except for recent months, households’ inflation expectations have tended to deviate significantly from the NBU's targets and projections, unlike the inflation expectations of businesses, banks, and financial analysts. This is partially driven by households’ propensity to overestimate current inflation. These overstated inflation expectations are commonplace in many other countries, which is associated with a number of factors.
Households tend to better remember increases in prices for goods than their decreases. Households pay more attention to prices for the most frequently used goods that are rapidly changing, such as food or gas prices. Inflation expectations are also largely responsible for shaping the structure of the individual consumer’s basket of goods. In addition, households’ inflation estimates differ depending on the person’s age, place of residence, and employment status.
In Ukraine, for instance, older people are more inclined to overestimate inflation than young people. Also, residents in Ukraine’s west have lower estimates of inflation than residents in other regions. In contrast to other countries, the level of education of Ukrainian households has little effect on perceptions of inflation, potentially indicating a lack of financial awareness. Deeper communications with the public and the introduction of financial literacy programs will help the NBU anchor inflation expectations and, hence, meet inflation targets.
- The Link Between Labor Productivity, Real Wages, and Inflation
Labor productivity, real wages, and inflation are closely interrelated economic concepts. An increase in real wages that outpaces productivity growth is a factor in increasing inflationary pressures through aggregate supply and aggregate demand channels. In addition, this indicator measures the economy’s efficiency and competitiveness. Thus, monetary policy decision-making is also informed by productivity analysis.
The growth in real wages in Ukraine significantly accelerated in previous years, regaining the ground it lost during the crisis of 2014–2015 when real wages plunged. Intensified migration processes, a significant increase in the minimum wage in 2017, and the deepening of imbalances between supply and demand for labor have also driven the growth in real wages. At the same time, despite the increase in Ukraine’s labor productivity, it remains considerably lower than in neighboring countries. In recent years, the rapid growth in real wages has become an additional contributor to inflation.
- Ukraine’s gross external debt: recent trends
In recent years, Ukraine’s gross external debt has been rather stable in nominal terms, and its ratio to GDP is gradually declining as the economy grows. Furthermore, the total amount of external debt takes into account the nonperforming loans of the real sector, including the debt of the companies in temporarily occupied territories, and the debt that arose from pseudo-foreign transactions. If these components were to be deducted from the external debt, its “true” size would be substantially lower.
At the same time, the debt-to-GDP ratio remains rather high compared to peer countries in particular. Also, the metrics of debt risk assessment show that Ukraine is highly vulnerable to abrupt changes in both the internal and external environments. This means that Ukraine must continue to conduct balanced fiscal and monetary policies, cooperate with the IMF and other international financial institutions, and develop the domestic financial market.
The inflation report reflects the NBU’s perspective on the current and future state of Ukraine's economy, with an emphasis on inflation, which is the basis of monetary policy decisions. The NBU has published the quarterly Inflation Report since April 2015.