The Board of the National Bank of Ukraine has taken a decision to cut its key policy rate to 15.5% per annum effective 25 October 2019. The NBU continues the cycle of monetary policy easing as inflation is firmly declining towards the target of 5%.
In September 2019, consumer inflation declined to 7.5% yoy, below the forecast published in the July Inflation Report. Inflation continued to slow in October according to the NBU’s preliminary estimates.
The steady disinflation has been driven by a gradual easing of underlying pressures on prices, reflected in a rapid slowdown of core inflation. The tight monetary policy was one of the reasons behind the strengthening of the hryvnia and improvement in inflation expectations. That has a major impact on prices, surpassing the effect of factors that push prices upwards, particularly the effect of the sustained consumer demand.
Same as before, inflation is projected to decline to 6.3% as of the end of 2019, meet the target range in early 2020, and reach the medium-term target of 5% at the end of 2020.
By the end of 2019, core inflation will slow more than expected, while fuel prices will remain below last year’s levels due to the stronger hryvnia. At the same time, supply of vegetables affected by unfavorable weather will put an upward pressure on prices. Therefore, considering the offsetting effect of these factors, the NBU maintains its inflation forecast for the end of 2019.
Same as this year, the tight monetary stance will continue to push inflation lower, to 5% in 2020–2021. Despite the gradual reduction in the key policy rate, its real value will remain high on the back of improved inflation expectations. Relatively high real interest rates will keep hryvnia financial instruments attractive for investors and thus influence the exchange rate of the national currency.
As a result, the more favorable FX market will neutralize the pressure domestic demand has on prices, which will be somewhat higher according to the new forecast.
Other factors behind the gradual disinflation will include:
- a prudent fiscal policy
- relatively low energy prices on the global markets
- an increase in food supply driven by higher productivity in agriculture.
Compared to the July macroeconomic forecast, the NBU has revised its economic growth forecast upwards, to 3.5% in 2019 and 2020 and 4% in 2021. The revision was driven by the sustained domestic demand, higher productivity in agricultural production, and improved consumer sentiment.
In the meantime, slower growth in the global economy and worsened terms of trade will weigh on economic growth in 2020.
Despite the stronger hryvnia, the current account deficit in 2019 will narrow to 2.9% of GDP, thanks to an improvement in the terms of trade and the rich grain harvest.
In 2020–2021, the current account deficit will widen slightly, as a result of a decrease in natural gas transit and less favorable global commodity prices (lower iron ore prices and gradually rising energy prices).
The current NBU forecast assumes the new IMF cooperation program will be approved by the end of 2019. This will allow Ukraine to attract other official financing, improve the conditions of access to the international capital markets, and support the interest of investors in Ukrainian assets.
As a result, notwithstanding the large external debt repayments, the international reserves will range at around USD 23–24 billion in 2019 and the following years, which is sufficient to cover three months of future imports.
When materialized, these risks could deteriorate exchange rate and inflation expectations, and make it harder for Ukraine to access the international capital markets in order to repay a heavy debt load in the coming years.
The following risks also remain important:
- the complete halt of the transit of Russian gas through Ukraine
- intensified trade tensions and more turbulent global financial markets
- an escalation of the military conflict and new trade restrictions introduced by Russia.
A more rapid decline in underlying inflationary pressures than anticipated, coupled with no change in the balance of risks, have made it possible to ease monetary policy somewhat more quickly this year than envisaged in the previous macroeconomic forecast. As a result, the Board has cut the key policy rate by 1 pp, to 15.5%.
As before, the largest decrease in the key policy rate is expected to take place in 2020, along with inflation returning to its target range and inflation expectations improving.
If the above inflation risks, both internal and external, materialize, the key policy rate could decline to 8% more slowly.
That said, the key policy rate could be cut, to 8%, much more quickly. These cuts will greatly depend on whether or not key internal reforms are sped up. These reforms are those that are envisaged in the memorandum of understanding signed by the Ukrainian government and the NBU, and the judicial reform required to establish the rule of law in Ukraine.
The decision to cut the key policy rate to 15.5% was approved by NBU Board Decision No.797-D On the Key Policy Rate, dated 24 October 2019.
A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 4 November 2019.
A new detailed macroeconomic forecast will be published in the central bank’s Inflation Report on 31 October 2019.
The next meeting of the NBU Board on monetary policy issues will be held on 12 December 2019 as scheduled.