National Bank cuts key policy rate to 13%

The NBU Board has decided to cut the key policy rate from 13.5% to 13% effective June 14, 2024 .

Given the still subdued inflation rate, the continued improvement in inflation expectations, and the balance of risks to further inflationary dynamics, the NBU continues its cycle of interest rate easing to support economic recovery

Consumer inflation remains below the NBU's target range

After a prolonged period of decline, inflation remained unchanged in April and only slightly increased in May to 3.3% year-on-year. This rate of consumer price growth was lower than the NBU had expected(Inflation Report, April 2024). As before, the deviation from the forecast was primarily driven by a sharp decline in raw food prices due to favorable weather conditions, the effects of last year's bumper harvest, and the reorientation of some producers to the domestic market.

Nevertheless, underlying inflationary pressures were in line with the NBU's April forecast, with core inflation at 4.4%, remaining within the target range for more than six months. On the one hand, the secondary effects of cheaper raw food products and the relative resilience of inflation expectations to exchange rate fluctuations restrained price growth for a wide range of goods and services. On the other hand, continued growth in business costs, including labor and electricity, drove up prices for a significant share of the components of the core consumer price index.

Inflation to accelerate by the end of the year, but remain moderate

The NBU expects inflation to accelerate moderately in the coming months and to reach its target range by the end of the year. Such price dynamics will be determined primarily by the continued pressure on business costs amid the war, likely slightly lower harvests after last year's record highs, the pass-through to prices of relatively high wage growth, and higher electricity tariffs.

At the same time, the NBU's prudent monetary policy and the moratorium on raising most housing and utility tariffs will continue to limit price growth. The NBU will not only continue its policy of protecting hryvnia savings from inflationary depreciation, but will also cover the structural deficit of foreign currency and smooth out excessive exchange rate fluctuations to ensure the stability of the foreign exchange market. These measures are important for maintaining control over inflation expectations, keeping inflation at a moderate level in 2024, and returning to the target range of 5% ± 1 pp in the coming years.

Continued international financial support and measures to strengthen the resilience of public finances provide the necessary foundation for maintaining macrofinancial stability

Budgetary needs in May and the first half of June were largely financed by funds received from international partners in the previous months. At the same time, foreign aid inflows are expected to pick up in the coming weeks. In particular, a staff-level agreement has already been reached on the fourth revision of the Extended Fund Facility program, so this month the country is expected to receive USD 2.2 billion from the IMF in addition to USD 1.5 billion from the IMF. The IMF is expected to provide USD 2.2 billion in addition to EUR 1.9 billion from the EU.

As the economy gradually recovers, the government is increasing tax revenues, which exceeded targets in January-May. Domestic borrowing remains an important tool for covering budgetary needs, as demand for hryvnia domestic government bonds remains high.

Given the expected receipts from international partners and domestic measures to mobilize financial resources, the government will be able to continue to provide significant state budget expenditures. At the same time, the NBU will maintain a comfortable level of international reserves sufficient to ensure a stable and controlled situation in the foreign exchange market.

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

Russian aggression, which has been going on for three years now, is causing significant economic losses to Ukraine and further fueling price pressure. While the NBU expects security risks to decrease and economic conditions to normalize in the coming years, the continuation of the war and the actual timing of its end remain major sources of uncertainty. A prolonged, high-intensity war that will deplete the country is the main risk to the economy.

Other risks also remain, most of which are also directly or indirectly related to the course of the war, including

• additional budgetary needs to maintain defense capabilities or cover significant quasi-fiscal deficits, particularly in the energy sector
• further damage to infrastructure, primarily 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 negative migration trends.

In addition, a potential increase in indirect taxes and excise duties to finance budgetary needs could have an additional contribution to inflation this year. At the same time, it will support the country's defense capabilities and the sustainability of public finances.

In addition, a number of scenarios are likely to materialize, including further expansion of export opportunities, acceleration of European integration processes, implementation of a large-scale recovery program, and transfer of funds from immobilized Russian assets to Ukraine. In particular, a decision on the use of Russia's immobilized assets is expected to be made following the G7 meeting, which may complement the decisions already taken in the US and the EU. The realization of such scenarios will reduce inflationary pressures and revive economic recovery.

Taking into account the balance of risks, the still subdued inflation rate, and the continued improvement in inflation expectations, the NBU Board decided to cut the key policy rate by 0.5 pp to 13.0%.

In recent months, hryvnia savings instruments remained in demand despite the gradual decline in nominal rates. Yields on hryvnia domestic government bonds and hryvnia deposits continue to protect savings from inflationary depreciation, so demand for them remains strong. The growth of households' hryvnia deposits with a maturity of 3 months or more has been stable and continues to exceed the growth of both short-term hryvnia and term foreign currency deposits. Households' investments in hryvnia domestic government bonds also continued to grow.

This allowed the NBU to continue cutting the key policy rate in line with its April macroeconomic forecast. This step is consistent with maintaining the protection of hryvnia savings from inflation, while at the same time contributing to a further revival in lending, which is important for economic recovery.

The baseline scenario of the April macroeconomic forecast envisaged a cut in the key policy rate to 13% this year, but the NBU is ready to adapt its monetary policy if the balance of risks to inflation and the foreign exchange market changes

Fundamental price pressures due to the war will persist, and inflation is expected to accelerate in the second half of the year. With this in mind, the NBU will aim to maintain moderate inflation this year and bring it back to the target range of 5% ± 1 pp in the coming years. If the balance of risks to inflation and the stability of the foreign exchange market changes, the NBU may revise the key policy rate forecast trajectory.

The reduction of the key policy rate to 13% per annum was approved by the NBU Board's decision No. 205-рш "On the Key Policy Rate" dated June 13, 2024, which comes into force on June 14, 2024.

A summary of the discussion of the Monetary Policy Committee members that preceded the NBU Board's decision will be published on June 24, 2024.

The next meeting of the NBU Board on monetary policy will be held on July 25, 2024, in accordance with the approved and published schedule.