The Board of the National Bank of Ukraine has decided to cut the key policy rate to 8%. The continued monetary easing aims to support the economy during the period of pandemic and quarantine.
In March–April, inflation was lower than expected, despite the temporary price growth in the first weeks of the quarantine
Last month, consumer inflation declined to 2.3% yoy. Price growth was restrained by three major factors: lower global energy prices, the residual effects of last year’s appreciation of the hryvnia, and a larger supply of raw foods. These factors outweighed the opposite pressure on prices from the weakening of the domestic currency in March and the panic buying of some goods after the quarantine was imposed.
According to preliminary data from NBU online monitoring, inflation will remain low in April. High demand for basic goods and unrest on the FX market caused by psychological factors waned quickly. As a result, prices for most food products and medicines, which had grown in the first weeks of the quarantine, have declined in recent weeks.
In 2020, inflation will remain within the target range of 5% +/- 1 pp. This will not be impeded by monetary and fiscal support to the economy
Inflation will accelerate moderately in the coming months, to reach 6% at the end of 2020, thus remaining within the target range. Fiscal and monetary policy measures that are aimed to support businesses and households will partially offset the decline in consumer demand. However, consumer demand will remain subdued for long after the quarantine ends, keeping inflation from growing above the target level this year.
Inflation will also be contained by declining global energy prices, which will continue to influence domestic fuel prices.
At the same time, the increase in inflation compared with the current level will be primarily driven by a pass through from the recent depreciation of the hryvnia.
In Q1 2021, inflation will temporarily deviate from the target range against a low comparison base. Afterwards, it will decrease and stabilize at the medium-term target of 5%. This level will be achieved thanks to the NBU’s prudent monetary policy and a more restrained fiscal policy after the pandemic ends and economic activity recovers.
The economy of Ukraine will contract by 5.0% in 2020 in the wake of the quarantine imposed to overcome the pandemic and due to the global crisis. However, it will resume growth at round 4% in the following years.
The adverse impact of the pandemic on the Ukrainian economy is expected to be relatively short-term, but strong. The quarantine has already affected business activity, consumption, and employment. A decrease in global demand has also limited export opportunities for Ukraine. According to NBU estimates, the effect of these factors will be the most pronounced in Q2 2020.
A gradual lifting of quarantine restrictions will allow the economy to recover in H2 2020. Loose fiscal and monetary policies will contribute to the economic recovery. An increase in budgetary spending by the government to overcome the crisis, along with the NBU’s actions to support the banking system, will mitigate the negative impact the pandemic has on the economy.
The NBU revised the forecast of current account deficit for 2020 downwards
This year, the current account deficit will be 1.7% of GDP (versus 3.2% in the January forecast). Imports of goods to Ukraine will decrease more than exports. Amid the worldwide quarantine and lower global prices, Ukraine will reduce its purchases of energy and the majority of nonessential goods. The pandemic will affect exports less, as demand for food products is expected to be maintained. At the same time, the decline in remittances from labor migrants will be more than offset by Ukrainians spending less on foreign travel.
The current account deficit will widen again once economic activity rebounds globally and in Ukraine. This will be driven by households’ pent-up demand for imported goods, the resumption of investment imports by businesses, and the expected decrease in gas transit revenues. Nevertheless, the deficit will continue to range between 3% and 4% of GDP, as envisaged in the NBU’s January forecast.
Continued cooperation with the IMF remains the key assumption of this macroeconomic forecast
Ukraine is close to having a new aid program approved by the IMF Executive Board. The NBU’s revised forecast envisages that Ukraine will receive the first tranche of about USD 2 billion in Q2.
First, this will cover the state budget deficit, which has increased to 7.5% of GDP. This will enable Ukraine to confidently pass through the period of peaking debt repayments, and finance measures to support businesses and households at a time when business activity is slowing down, employment and tax revenues are falling, and foreign investors are leaving emerging markets.
Second, financing from the IMF and other official international partners will help maintain Ukraine's international reserves at USD 27 to 29 billion this year and in the coming years.
In this light, signing a new aid program with the IMF is the main prerequisite for maintaining macro-financial stability in Ukraine during the global crisis. Therefore, the absence of a program with the IMF remains the main risk to this forecast.
Another important risk to the outlined forecast could arise from a longer-lasting novel coronavirus pandemic and, consequently, longer-lasting quarantine measures being required to overcome the outbreak
This will have a direct influence on how quickly the global and Ukrainian economies recover.
Other risks also remain significant. They include:
- an escalation of the military conflict in eastern Ukraine
- 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 and the risk of stronger protectionist measures.
In this light, the NBU Board decided to cut the key policy rate considering that inflationary pressures were moderate, and the economy required substantial support due to the adverse impact of quarantine measures on business activity, consumption and employment.
In view of the above, the NBU continued to ease monetary policy, by cutting the key policy rate by 2 pp, to 8%.
Together with other measures taken by the NBU, such as expanding its set of liquidity support tools and the introduction of preferential terms for borrowers by banks, this will provide the economy with the impetus required to provide support for households and businesses in these difficult times, and to ensure that business activity picks up quickly once the quarantine is lifted.
The NBU expects that the key policy rate to be reduced further, to 7% in the current year
In deciding how quickly the key policy rate can be decreased to that level, the NBU will take into account how talks with the IMF progress, how the coronavirus pandemic develops, how quickly quarantine measures are lifted, and what anti-crisis measures other governments and central banks adopt.
The NBU leaves open the possibility of a greater easing in monetary policy if a fall in consumer demand due to quarantine measures and weaker business activity put stronger downward pressure on inflation than is currently expected.
The decision to cut the key policy rate, to 8%, was approved by NBU Board Decision on the key policy rate No.289_D, dated 23 April 2020.
A new detailed macroeconomic forecast will be published in the central bank’s Inflation Report on 30 April 2020.
A summary of the discussion by Monetary Policy Committee members that preceded this decision will be published on 4 May 2020.
The next meeting of the NBU Board on monetary policy issues will be held on 11 June 2020, as scheduled.