The National Bank of Ukraine (NBU) cut its key policy rate by 150 basis points to 11.0 percent and has now cut it by a total of 700 points since it began its easing cycle in April 2019.
A steady rise in Ukraine's hryvnia from September 2018 through December 2019 along with low energy and food prices has pushed down Ukraine's inflation rate faster than expected.
In December headline inflation fell to a 6-year low of 4.1 percent from 5.1 percent in November and 9.8 percent in December 2018, in the lower end of NBU's target of 5.0 percent, plus/minus 1 percentage point.
"The strengthening of the hryvnia was the key factor driving the rapid disinflation seen in late 2019, offsetting the effects of robust consumer demand," NBU said.
NBU expects inflation to remain below its target range starting in January and most of this year before accelerating to 4.8 percent in the fourth quarter of 2020, mainly because the rise in the hryvnia will continue to be reflected in import prices, low energy prices will hold back domestic fuel prices, and food price inflation should be insignificant in the absence of supply shocks.
Administered prices, however, will grow somewhat faster than in 2019, mainly as taxes on tobacco products continue to converge to European levels, NBU said.
Based on its expectation of lower interest rates, NBU expects inflation in 2021 and 2022 to remain within its medium-term target, supported by prudent fiscal policy, low energy prices and higher productivity.
If inflation risks materialize, NBU cautioned it could slow the pace of rate cuts and conversely if reforms are implemented faster than expected along with significant inflows of investment, the rate could be cut at an even faster pace.
In 2019 the hryvnia appreciated almost 20 percent but since late December it has given back some of those gains to trade at 24.9 to the U.S. dollar today, down almost 5 percent this year.
Ukraine's economy is expected to continue to strengthen in coming years and NBU confirmed its earlier forecast for growth this year of 3.5 percent, up from 3.3 percent in 2019, rising to around 4.0 percent in following years.
The current account deficit narrowed to only 0.7 percent of gross domestic product in 2019, partly after Ukraine's state-owned gas company Naftogaz received $2.9 billion from Russia's Gazprom after a legal battle was settled.
In 2020-22 NBU expects a current account deficit of 3-4 percent of GDP, a level it described as "acceptable," with the deficit caused by large investment imports and lower revenue from natural gas transit amid greater capital inflows to the private sector.
"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.
Throughout most of 2020, inflation will be below the 5±1 pp target range, but it will return to the target range at the end of the year
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.
In 2020 economic growth will accelerate to 3.5%, up from 3.3% in 2019, while accelerating to around 4% in the following years
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 2020–2022 current account deficit will remain acceptable
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.
Further cooperation with the International Monetary Fund remains the basic assumption of the macroeconomic forecast
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.
In light of the more rapid improvement in Ukraine’s macroeconomic conditions, the NBU expects to cut the key policy rate to 7% by the end of 2020
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."
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