The NBU explains why it raised the key policy rate

The Board of the National Bank of Ukraine has decided to raise the key policy rate to 14.5% per annum. This decision is aimed at maintaining the stability of the foreign exchange market, keeping inflation expectations under control, reversing the inflation trend, and gradually slowing inflation to the 5% target. Containing price pressures will likely require further tightening of interest rate policy.

Inflation reached 12% in 2024, with price pressures persisting in early 2025

In December 2024, inflation accelerated to 12% year-on-year, exceeding the NBU's previous forecast. The NBU estimates that inflation continued to accelerate in January.

High consumer price growth was largely driven by temporary factors. At the same time, underlying price pressures were also increasing. This is evidenced by a further acceleration in core inflation (to 10.7% yoy in December), in particular due to a rapid rise in service prices.

This price development was driven by higher business costs for raw materials, supplies, and electricity, as well as higher wages amid a persistent shortage of staff. At the same time, in recent months, price growth has been restrained to some extent by the strengthening of the hryvnia against the euro, which is important for Ukrainian imports.

Inflation reaching double-digit levels has a negative impact on inflation expectations of households and businesses. However, the expectations of financial analysts and banks remain relatively stable.

Thanks to the exhaustion of temporary factors of price pressure and the NBU's interest rate and exchange rate policy measures, inflation will slow to 8.4% in 2025 and to the 5% target in 2026.

In the first months of 2025, inflation is likely to continue to rise due to the continued influence of both temporary factors, such as the effects of last year's lower harvests, and fundamental factors, such as pressure from business production costs. Inflation will peak in the second quarter of the year and begin to decline in the middle of the year.

Inflation is expected to slow to 8.4% by the end of 2025, and to the 5% target in 2026. This will be supported by the NBU's interest rate and exchange rate policies, as well as higher harvests, improved energy situation, lower fiscal deficit, and moderate external price pressure.

Economic recovery will continue, although it will be limited due to the effects of the war

Thanks to significant international support, as well as a high level of adaptability of businesses and households to the war, Ukraine's economy continues to recover.

The NBU estimates that Ukraine's real GDP will grow by 3.4% in 2024, which is less than the NBU's October forecast. Economic growth slowed compared to 2023.

This is due not only to poorer harvests and somewhat weaker than expected external demand, but also to the realization of the risks of increased hostilities, intensified Russian air attacks, and related electricity shortages. The persistence of high security risks also hindered the return of migrants and caused a significant labor shortage.

Given the security risks and the difficult situation on the labor market, the NBU has lowered its real GDP growth forecast for 2025 to 3.6%. At the same time, the NBU's baseline scenario still assumes a gradual return of the economy to normal operating conditions.

Accordingly, in 2026-2027, economic growth is expected to moderately accelerate to about 4%. On the one hand, the effects of the war, which have affected the labor shortage and lack of production capital, will continue to constrain the economy. On the other hand, investments in energy and production capacities, a relatively loose fiscal policy, and growth in private consumption amid rising household incomes will contribute to the recovery.

International support will be sufficient to finance the budget deficit without issuing new debt and to maintain a stable situation in the foreign exchange market.

In 2024, Ukraine received USD 42 billion from international partners. Ukraine received USD 42 billion from international partners in the form of loans and grants.

These funds allowed the government to finance a significant budget deficit, and the NBU to maintain the stability of the foreign exchange market and increase international reserves to a new all-time high (USD 43.8 billion at the end of 2024).

In 2025, Ukraine is expected to receive USD 38.4 billion in external financing. In 2015, Ukraine is expected to receive USD 38.4 billion in external financing. Given the government's measures to increase its own revenues and to raise funds on the domestic debt market, these funds should be enough to fully cover the planned budget deficit for next year without resorting to issuance sources.

For its part, the NBU will be able to compensate for the structural shortage of foreign currency in the private sector and smooth out excessive exchange rate fluctuations. This will make it possible to maintain the stability of the foreign exchange market under a regime of managed exchange rate flexibility, which will be consistent with the achievement of the 5% inflation target on the policy horizon.

The key risk to inflationary dynamics and economic development remains the ongoing full-scale war

The war continues. Russian aggression poses risks of a further decline in economic potential, in particular due to the loss of people, territory, and production facilities. The speed of the economy's return to normal conditions will depend on the nature and duration of hostilities.

The main risks caused by Russian aggression remain unchanged:

• additional budgetary needs, primarily to maintain defense capabilities;
• possible additional tax increases, which, depending on the parameters, may increase price pressure;
• further damage to infrastructure, especially energy infrastructure, which will limit economic activity and put pressure on prices from the supply side;
• deepening of negative migration trends and further expansion of the labor shortage in the domestic labor market.

There are also risks that international aid will become less rhythmic and that foreign economic trends will be less favorable than currently expected, in particular due to greater geopolitical polarization and the corresponding fragmentation of global trade.

However, positive scenarios may also materialize, primarily due to increased financial support from partners (in particular, by using the bulk of immobilized Russian assets to compensate for Ukraine's losses) and the international community's efforts to ensure a just and lasting peace for Ukraine. In addition, further acceleration of European integration processes and rebuilding of infrastructure, including energy, is possible.

In order to maintain the stability of the foreign exchange market, keep expectations under control, and gradually bring inflation to the 5% target on the policy horizon, the NBU Board decided to raise the key policy rate by 1 pp to 14.5%.

The acceleration of inflation in the second half of 2024 and the resulting deterioration in household inflation expectations led to a decline in the real yield on hryvnia savings instruments.

The key policy rate hike is aimed at ensuring that hryvnia savings are adequately protected from inflation and at maintaining households' interest in hryvnia assets. This will help reduce pressure on the foreign exchange market and prices.

The NBU's updated macroeconomic forecast envisages further key policy rate hikes to curb inflation

The NBU is likely to continue tightening its interest rate policy at upcoming monetary policy meetings if signs of persistent inflationary pressures and the threat of an imbalance in inflation expectations persist.