NBU keeps key policy rate at 18%, updates macroeconomic forecast

The National Bank of Ukraine (NBU) announced on Jan.
31 it decided not to change its key policy rate at its board meeting that day,
keeping it at 18% since July. The central bank noted that keeping the key
policy rate at this rate will lower annual inflation to 5% in 2020, according
to its press release. Consumer inflation dropped  to 9.8% yoy in
2018  from 13.7% yoy in 2017, the lowest in the last five years. The
central bank believes that tight monetary policy was the major factor in
curbing inflation, as consecutive increase of key policy rate increased the
public’s propensity to consume. In addition to monetary factors, the NBU also
cited increased domestic supply of some foods and the decline of global food
prices as important contributors to slowing inflation.

The NBU also confirmed its inflation forecast of 6.3%
yoy in 2019 and 5.0% yoy in 2020. The upper end of the 4-6% target range should
be reached in the beginning of 2020. Other inflation-restraining factors
include prudent fiscal policy, slower growth of wages, relatively low
volatility of the exchange rate, lower global prices for energy resources, and
slow price growth for food commodities.

The downside of its tight monetary policy will be the
slowdown of economic growth, the NBU admitted. The central bank expects
Ukraine’s GDP growth to slow to 2.5% yoy in 2019 from 3.3% yoy growth in 2018
(according to the latest NBU estimate). A lower grain harvest (after the record
high reached in 2018) and cooling growth of the world economy will be
additional factors of Ukraine’s economic slowdown in 2019.  The NBU
expects economic growth to accelerate to 2.9% yoy in 2020 and 3.7% yoy in 2021.

The NBU estimates that current account deficit amounted
to 3.6% of GDP in 2018, and it will stay at 3-4% of GDP in 2019-2021. The
deficit will shrink to 3.1% in 2019 due to expected growth of corn exports and
lower energy prices. In 2020-2021, the current account deficit will enlarge due
to the decline in gas transit, lower grain crops and increased imports of
investment goods. The enlarged trade deficit will be compensated by the growth
of private remittances by laborers abroad.

The key assumption of the NBU’s forecast is the
continuing cooperation of Ukraine with the IMF and the accessibility of global
financial markets for Ukraine. If these conditions hold, the NBU expects to
keep its gross international reserves at USD 21 bln in 2019-2020. The
increasing uncertainty related to presidential and parliamentary elections in
2019 is cited as a major risk to NBU projections.

The NBU noted that it might soften its monetary policy
as soon as there is a consistent reduction of inflation-related risks, and the
inflation trend will be in line with the central bank’s projections. At the
same time, it can’t rule out a key policy rate hike in case of increased
fundamental inflationary risks and the realization of forecast risks.

Evgeniya Akhtyrko: It looks
like the most of the NBU’s monetary committee members didn’t share the optimism
of Governor Yakiv Smoliy, who recently stated that there are
grounds for softening the central bank’s monetary policy.
Indeed, it is better to wait until the slowing inflation trend extends for
several months.

The next revision of the key policy rate is
scheduled for March 14. By that time, it will be more clear whether or not the
inflation trend keeps pace with the NBU’s expectations. In case of a confident
downward inflation trend, the central bank is likely to lower the key policy
rate by 0.5 pp.