NBU Cuts Key Policy Rate to 11%

The Board of the National Bank of Ukraine has decided to cut the key policy rate to 11% per annum effective 31 January 2020. The NBU continues to ease its monetary policy with the aim of maintaining inflation at the target level of 5% and supporting steady economic growth.

In 2019 consumer inflation declined to a six-year low of 4.1% (versus 9.8% in 2018). The NBU thus achieved its medium-term inflation target of 5% ± 1 pp (declared in 2015) earlier than expected. The strengthening of the hryvnia was the key factor driving the rapid disinflation seen in late 2019, offsetting the effects of robust consumer demand. 

According to the NBU’s estimates, inflation continues to slow. It will be below the 5±1 pp target range starting in January and throughout most of the year. However, it will accelerate in Q4 to 4.8% at year-end 2020.

This will be due to the following factors. First, the last year’s appreciation of the hryvnia will continue to be reflected in prices of imported goods and products with a large share of imported inputs. Second, continued relatively low global energy prices will curb the rise in domestic fuel prices. Third, in the absence of supply shocks, food price inflation will be insignificant owing to expected higher yields of fruit and vegetables.

At the same time, administered prices will grow somewhat faster than last year, mainly as excise taxes on tobacco products continue to converge with European levels.

Driven by the monetary policy easing, inflation in 2021–2022 will remain within the medium-term target of 5+/-1% pp. The further steady, low pace of inflation will also be due to the following factors:

• a prudent fiscal policy
• relatively low energy prices on the global markets
• higher productivity of the Ukrainian economy.

The monetary policy easing will contribute to the faster economic growth. High private consumption and investment will remain the main economic growth drivers. At the same time, the contribution of net exports to GDP will remain negative on the back of the real sector’s considerable need for investment imports.

Real household income will grow at a fast pace, which will further narrow the wage gap with neighboring countries and thus make Ukrainians more interested in working in Ukraine rather than abroad.

The deficit narrowed to 0.7% of GDP in 2019. An important factor behind the decrease in the deficit was the compensation received by Naftogaz of Ukraine from Russian Gazprom under a ruling of the Stockholm Arbitration Court. However, apart from that, the current account deficit shrank due to the decreased trade deficit in goods and services, steady growth in services exports, and smaller amounts of repatriated dividends.

The current account deficit will range from 3% to 4% in 2020–2022. In particular, the wider deficit will be caused by large volumes of investment imports and decreased proceeds from natural gas transit. However, this will be offset by greater capital inflows to the private sector amid an improvement in the investment climate.

The NBU expects that a new cooperation program with the IMF will be signed in the coming months, after the Ukrainian parliament approves the required draft laws. The new cooperation program, official borrowing and nonresidents’ sustained interest in domestic Treasury bonds and bills will sustain the rise in international reserves every year, despite Ukraine going through a period of peak external public debt payments. International reserves will exceed USD 29 billion in 2020, and will continue to rise in 2021–2022.

As before, the NBU believes any delay in entering into a new cooperation agreement with the IMF to be the key risk to the said macroeconomic forecast. Risks to macrofinancial stability also persist. These risks could mainly arise from Ukrainian court rulings on the responsibility and liability of the former owners of insolvent banks to the state. 

If materialized, these risks could worsen exchange rate and inflation expectations, and make it harder for Ukraine to access the international capital markets in order to repay the heavy debt load of the coming years.

There are other significant risks. They include:

• the continued cooling of the global economy and a further deterioration in terms of trade
• an escalation of the military conflict in eastern Ukraine and new trade restrictions introduced by Russia
• a drop in the harvest of grain, fruit and vegetable crops in Ukraine in the wake of unfavorable weather
• the higher volatility of global food prices, driven by global climate change
• a decrease in foreign capital inflows.

The outlined macroeconomic forecast and the unchanged balance of risks have enabled the NBU Board to cut the key policy rate by as much as 2.5 pp. This monetary policy easing will help revive lending to the real sector and speed up economic growth.

The most pronounced reduction in the key policy rate is expected to take place in H1 of the current year. This will lead to further decreases in interest rates on loans for businesses and households, thus stimulating business activity.

That said, if the above inflation risks, both internal and external, materialize, the key policy rate could be decreased more slowly.

Conversely, faster implementation of reforms, coupled with significant investment inflows, could enable the NBU to cut the key policy rate at a quicker pace.

The decision to cut the key policy rate to 11% was approved by NBU Board Decision No.76-D On the Key Policy Rate, dated 30 January 2020.

A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 10 February 2020.

А new detailed macroeconomic forecast will be published in the Inflation Report on 6 February 2020.

The next meeting of the NBU Board on monetary policy issues will be held on 12 March 2020, as scheduled.