The NBU cuts the key policy rate to 13.5%

The NBU Board has decided to cut the key policy rate from 14.5% to 13.5% effective April 26, 2024.

Given the easing of actual and expected price pressures, as well as reduced risks to international financial support, the NBU continues its cycle of interest rate easing. This will allow the NBU to support credit growth and economic recovery without additional risks to price and financial stability.

Consumer inflation decelerated faster than the NBU expected in the first quarter of 2024

Actual consumer inflation decelerated to 3.2% yoy in March, which was lower than the NBU's forecast in its January 2024 Inflation Report. The deviation from the forecast was primarily due to unpredictable factors, including those of a temporary nature. For example, warm winter weather resulted in an increased supply of raw foods, and helped ease pressure on business costs, particularly energy costs. In addition, the effects of the previous year's bumper harvest continued to be reflected.

Core inflation also decelerated (to 4.2% yoy), but was quite close to the NBU's forecast. On the one hand, the continued rise in labor costs and the effects of the blockade of the western borders maintained underlying price pressures. On the other hand, it was eased by improved inflation expectations and the pass-through effects of cheaper raw foods to processed foods and some services.

The NBU has improved its inflation forecast to 8.2% for 2024 and expects inflation to remain within the target range of 5% ± 1 pp over the coming years

As before, the NBU forecasts a moderate increase in inflationary pressures this year, given the expected exhaustion of the effects of the previous year's large harvests, further recovery in consumption, and higher business spending in the war. At the same time, given the better actual inflation dynamics and improved inflation expectations, the inflation forecast for the end of this year has been lowered from 8.6% to 8.2%.

Over the next few years, inflation will return to the 5% ± 1 pp target range and remain within it. This will be facilitated by the gradual normalization of economic conditions, the easing of external inflationary pressures, and consistent monetary policy measures by the NBU. Inflation is expected to slow to 6% by the end of 2025, and to 5% by 2026.

The economic recovery will continue, although it will be restrained, primarily due to significant damage to energy facilities

According to the NBU, real GDP growth in the first quarter of 2024 was weaker than expected, primarily due to restrained budget spending amid uncertainty over external financing. An additional factor was the blockade of the western border, which restrained the activity of certain types of business. At the same time, the stable operation of the maritime corridor, favorable weather, and increased domestic demand supported economic growth.

The NBU forecasts a further recovery in economic activity, given the recent progress in obtaining international assistance, as well as the expected recovery in domestic and external demand. At the same time, the forecast for real GDP growth has been downgraded due to the effects of Russia's large-scale attacks on Ukraine's energy infrastructure. The economy is expected to grow by 3% in 2024 and by 4.5-5% in 2025 and 2026.

Continued international financial support and measures to strengthen the resilience of public finances will help to further ensure the macrofinancial stability necessary for a sustainable economic recovery

As expected, in March, Ukraine received about USD 9 billion from international partners. This allowed the NBU to increase international reserves to almost USD 44 billion. THIS ALLOWED UKRAINE TO INCREASE ITS INTERNATIONAL RESERVES TO ALMOST 44 BILLION US DOLLARS. In addition, in recent days, Ukraine has received positive news from the United States about the approval of a military and financial aid package. Another tranche of EUR 1.5 billion has also been received from the EU. Given this, Ukraine can count on $38 billion in foreign budgetary aid this year. The country can expect to receive $38 billion in external budgetary aid this year.

At the same time, measures to strengthen Ukraine's self-sufficiency continue. The government is strengthening its own resource base and increasing domestic borrowing. For its part, the NBU is improving currency control measures. Together with the rhythmic flow of foreign aid, this will allow the NBU to finance planned budget expenditures and maintain a controlled situation on the foreign exchange market.

The key risk to inflation and economic development remains a full-scale war

Russia's full-scale aggression continues, causing new losses to the Ukrainian economy. The NBU assumes that security risks will decrease and that conditions for the economy's functioning will normalize over the forecast horizon. However, a prolonged high-intensity war threatens to further destroy cities, infrastructure, and production facilities, the extent of which is difficult to estimate in advance.

Compared to the previous forecast, the risk of insufficient international financing this year has eased significantly, but the risks of rhythmic inflows remain. The following risks also remain relevant

• additional budgetary needs to maintain defense capabilities or cover significant quasi-fiscal deficits, particularly in the energy sector
• significant damage to infrastructure, especially energy and port infrastructure, which will limit economic activity and put pressure on supply-side prices;
• continued partial blocking of borders by some EU countries for freight transportation, which will restrain exports and increase imports;
• deepening of negative migration trends;
• aggravation of the situation in the Middle East, which, in particular, increases the risks of possible disruptions in energy supplies and their rise in price for the global economy.

At the same time, a number of positive scenarios are still likely to materialize, including further expansion of export opportunities, transfer of funds from immobilized Russian assets to Ukraine, acceleration of European integration processes, and implementation of a large-scale recovery program.

Taking into account the balance of risks and favorable macrofinancial trends, including better inflation dynamics, the NBU Board decided to cut the key policy rate by 1 pp to 13.5%.

The previous steps to ease interest rate policy and changes in the operational design of monetary policy were expected to result in a gradual decline in nominal yields on hryvnia deposits and domestic government bonds. At the same time, these instruments remained attractive, and demand for them remained strong, given the overall improvement in inflation expectations. A moderate cut in the key policy rate should not hinder interest in hryvnia assets, as they will continue to protect savings from inflationary depreciation.

Along with the key policy rate cut, the NBU also reduced interest rates on overnight and three-month certificates of deposit by 1 pp, to 13.5% and 16.5%, respectively. In addition, the NBU is cutting interest rates on refinancing loans more significantly - by 2 pp to 17.5%. In the context of the interest rate policy easing cycle, it is no longer advisable to maintain a significant difference between the refinancing rate and the key policy rate.

Given the fairly comfortable level of international reserves, the controlled situation on the foreign exchange market, and expectations of further international assistance, the NBU is preparing a series of steps to liberalize the currency in the coming weeks. These steps will be consistent with the strategy of easing currency restrictions, moving to greater exchange rate flexibility, and returning to inflation targeting. These steps have already been taken into account in the updated macroeconomic forecast, which assumes that international reserves will remain close to the current level this year and next.

The NBU sees some room for further easing of interest rate policy, provided that favorable macrofinancial trends continue

The baseline scenario of the NBU's forecast envisages a cut in the key policy rate to 13% this year. This easing of interest rate policy and the planned steps toward currency liberalization should not pose additional threats to macrofinancial stability and FX market resilience.

The NBU will adapt its monetary policy in the event of significant changes in the balance of risks. For example, reducing risks to inflation and exchange rate stability may create preconditions for additional steps to cut the key policy rate and ease currency restrictions, which will support lending and economic recovery.

A summary of the discussion by Monetary Policy Committee members that preceded the NBU Board's decision will be published on May 6, 2024.

The next meeting of the NBU Board on monetary policy will be held on June 13, 2024, in accordance with the approved and published schedule.