Dear colleagues,
Please be informed that the NBU Board has decided to raise the key policy rate to 8% per annum.
Given the significant increase in underlying inflationary pressures, this step is necessary to return inflation to 5% in 2022 and keep inflation expectations in check.
What price developments followed the last monetary policy meeting?
Inflation was above upper bound of its 5% ± 1 pp target range, as expected. In June, the pace of growth in consumer prices remained at 9.5% yoy, the rate of the previous month. At the same time, inflation continued to deviate from its target range more significantly than in the NBU’s April macroeconomic forecast.
On the one hand, the surge in inflation was primarily due to temporary increases in global food and energy prices.
On the other hand, underlying inflationary pressures intensified. Specifically, core inflation in June accelerated to 7.3% yoy and significantly exceeded the April forecast.
Inflationary pressures were to some extent restrained by favorable FX market conditions and relatively stable inflation expectations.
How will prices behave going forward?
After peaking in the fall of this year, inflation will begin to slow.
This will be due to several factors:
- the effect of the low comparison base will fade
- a new harvest will hit the markets
- global energy prices will adjust
- the tightening of the NBU’s monetary policy, in particular through the key policy rate hike and the rollback of emergency monetary measures, will have an effect.
As a result, inflation will decline at the end of this year, return to its 5% target in the second half of next year, and remain close to this level going forward.
What will be the overall state of the Ukrainian economy?
The NBU has maintained its 2021 real GDP growth forecast at 3.8%. Robust consumer demand, benign foreign trade conditions, and large harvests will make up for the losses to the Ukrainian economy due to the winter and spring lockdowns, poor weather conditions, and the late start of the harvesting campaign.
In 2022–2023, the economy will grow by about 4% annually. This growth will be driven by:
- high private consumption
- strong demand for Ukrainian exports
- a revival of investment activity by businesses.
It is expected that in 2021, the current account of the balance of payments will record a deficit of 0.4% of GDP due to growing domestic demand, the resumption of foreign tourism, and higher dividend payments. These factors will only be partially offset by good terms of trade and record grain yields.
In the next two years, the current account deficit will widen significantly as domestic demand continues to rise and terms of trade worsen.
Under what conditions would this forecast be realized?
The primary assumption of the NBU Board is that Ukraine will continue to cooperate with the IMF.
The central bank expects that Ukraine will achieve progress in negotiations with the IMF. Long delays in the performance of the agreement on cooperation with the IMF would create risks to financing the state budget deficit, mainly in the coming years. This could also deteriorate inflation and exchange rate expectations, forcing the central bank to tighten its monetary policy.
Conversely, the performance of the IMF cooperation program would enable Ukraine to raise the planned amount of official financing, while making it cheaper to borrow on the external and domestic markets. This would also help maintain Ukraine’s international reserves at USD 29 to 31 billion in 2021 – 2023.
The key risks to the macroeconomic forecast are the imposition of stricter quarantine measures in Ukraine and globally, and a longer and more pronounced than expected surge in global inflation.
On the one hand, the Ukrainian economy could sustain new economic losses because of new coronavirus variants, such as the Delta variant, which are spreading rapidly across the world.
On the other hand, the probability of a longer and more pronounced surge in global inflation is rising, driven by significant fiscal and monetary stimuli. This creates risks of stronger pro-inflationary pressures in Ukraine, and of leading central banks tightening their monetary policies more quickly. This could decrease investors’ interest in the emerging markets, including Ukraine.
Other pro-inflationary risks remain important, such as an escalation of the military conflict with Russia and a sharp deterioration in terms of trade.
In view of the above, the NBU decided to raise the key policy rate to, 8%, and to strengthen monetary policy through some additional measures.
- First, the NBU will continue to phase out anti-crisis measures, as planned.
- Second, from 23 July, the central bank will set the interest rate on refinancing loans at the level of the key policy rate + 1 pp for quantitative tenders, and no less than this level for interest rate tenders.
- Third, from 1 August, the NBU will decrease the planned amounts of its daily interventions to purchase FX on the interbank FX market from USD 20 million to USD 5 million.
What will the NBU’s monetary policy stance be in future?
The NBU’s forecast envisages that the key policy rate will be raised further, to 8.5%, and maintained at that level until Q2 2022. That should be sufficient to bring inflation back to its 5% target in 2022.
If additional pro-inflationary risks materialize, the NBU stands ready to continue deploying monetary tools to return inflation to its 5% target.
Thank you for your attention!