Inflation will begin to decline in the middle of the year, and economic growth will accelerate - Inflation Report
According to the NBU's updated forecast, inflation will rise in the coming months, but will start to decline in the middle of the year. By the end of 2025, it will reach 8.4%, and by 2026, it will return to the NBU's 5% target. Real GDP will increase by 3.6% this year, and over the next two years, economic growth will accelerate to about 4% per year.
The baseline scenario of the NBU's forecast is based on the assumptions that sufficient international support will be maintained and that the economic environment will gradually normalize, which will, in particular, facilitate the partial return of forced migrants and investment growth. A detailed analysis and forecast of the macroeconomic situation is published in the Quarterly Inflation Report for January 2025.
The NBU's interest rate policy is aimed at reducing inflation this year and bringing it to the 5% target in the future
The NBU made two key policy rate hikes - by 0.5 pp in December and 1 pp in January - to support FX market stability, keep expectations under control, and gradually bring inflation to the 5% target over the policy horizon. The NBU's forecast envisages further tightening of interest rate policy in the first half of 2025 to contain price pressures.
The increase in the key policy rate will encourage banks to raise interest rates on hryvnia deposits, which will provide better protection of hryvnia savings from inflation. This will also help to improve inflation expectations and partially reorient household spending from consumption and foreign currency purchases to hryvnia savings. This will ease pressure on the FX market and prices.
Despite the expected decline in international aid in the coming years, the level of international reserves will remain higher than before the full-scale invasion and will be sufficient to allow the NBU to continue to maintain FX market stability. This will support the NBU's ability to achieve its inflation target over the policy horizon.
Inflation will peak in the second quarter of the year and then begin to decline
The acceleration of inflation in the coming months will reflect a tight supply of food due to last year's poor harvest, as well as higher production costs, including energy and labor. However, this trend will not last. Inflation is expected to peak in the second quarter and begin to decline in the middle of the year. The NBU forecasts that inflation will slow to 8.4% by the end of 2025.
The slowdown in inflation will be driven by the NBU's interest rate policy measures, the stability of the FX market, the expansion of food supply with the arrival of a new harvest, the narrowing of the fiscal deficit, and moderate external price pressure. Disparities in the labor market will weigh on prices, but the contribution of this factor will gradually decline as wage growth slows. In addition, business investments in energy independence have largely already been reflected in prices, so amid expected declines in energy deficits, this factor will also help to reduce inflation.
With the gradual normalization of economic conditions, further improvement in the energy and labor markets, a significant reduction in the budget deficit, and the effects of the NBU's monetary policy measures, consumer inflation will return to the NBU's 5% target in 2026.
Economic growth will accelerate to 3.6% in 2025 and to around 4% in the following years
The economy will grow thanks to investments in rebuilding energy and production capacities, loose fiscal policy, a revival in domestic demand, and increased production due to higher harvests. As the economy returns to normal, migrants will begin to gradually return, which will also support GDP growth.
Real GDP is now close to its potential level and will remain close to it in the future. Potential GDP will grow due to higher productivity. However, the growth rate will be constrained by the effects of the war, in particular, by a shortage of labor and limited investment in productive capital.
Employment and wages will gradually increase amid a labor shortage and economic recovery
Driven by strong demand for labor, unemployment will decline but remain higher than before the full-scale invasion (around 10-11% in 2025-2027) due to the persistence of significant imbalances between the needs of employers and the knowledge and skills of potential workers. At the same time, wages will continue to rise given the high competition for skilled workers among businesses.
According to the SSSU, in 2024, real wages have already exceeded the level before the full-scale invasion in most sectors of the economy. Wages are expected to continue to grow, although as the labor market gradually improves, the annual rate of increase in real terms will slow to 3-4% in 2025-2027.
The support of international partners, together with borrowings on the domestic debt market, will make it possible to cover the budget deficit without using emission financing
The consolidated budget deficit excluding grants in revenues will gradually narrow over the forecast horizon (from 19% of GDP in 2025 to 7% of GDP in 2027), which will be facilitated by the strengthening of the domestic resource base amid further economic growth. International assistance, together with borrowings from the domestic market, will help to finance budgetary needs without issuing debt. Ukraine is expected to receive USD 38.4 billion from international partners this year. THIS YEAR, UKRAINE IS EXPECTED TO RECEIVE USD 38.4 BILLION FROM INTERNATIONAL PARTNERS. The risk of not receiving the expected funding is low. At the same time, the amount of international assistance may be increased or brought closer in time.
In addition to the updated macroeconomic forecasts, the January Inflation Report covers a number of special topics:
- factors that caused inflation to deviate from the target in 2024.
In December 2024, consumer inflation reached 12.0% yoy, and core inflation reached 10.7% yoy. The acceleration of inflation in the second half of 2024 was expected, but the actual figure exceeded the NBU's previous forecasts. The deviation of inflation from the NBU's 5% target was caused by a number of factors, primarily temporary ones.
For example, last year, due to unfavorable weather conditions, harvests were low, which reduced the supply of food. The impact of fundamental factors also increased due to a further increase in business costs for energy and labor. In addition, electricity tariffs for households and certain excise taxes increased.
Monetary policy measures were a factor that restrained inflationary pressures. Maintaining the key policy rate at 13% and raising it further to 13.5% in December, along with ensuring the stability of the foreign exchange market, restrained the deterioration in inflation and exchange rate expectations and supported the attractiveness of hryvnia instruments for savings. In addition, the hryvnia strengthened against the euro at the end of the year. This helped ease price pressures somewhat.
The cost of certain housing and utility services for households (natural gas, heating, and hot water) remains below the level that would be consistent with global gas prices. Accordingly, the moratorium on raising tariffs for certain housing and utility services also limited the acceleration of inflation;
- parameters of the state budget in 2025.
The state budget of Ukraine for 2025 was approved with a deficit of 20.4% of GDP, excluding grants in revenues. The key area of expenditures is defense: defense and security expenditures amount to 26% of GDP. The planned state budget deficit in 2025 is lower than the actual figure for 2024. However, the fiscal policy will remain quite loose, which will support the economy during the war, while gradual fiscal consolidation will help stabilize the public debt level.
The main parameters of the state budget are based on a rather conservative forecast. On the one hand, higher inflation and imports than the NBU's forecast in the budget create risks of a shortfall in tax revenues. On the other hand, the government's estimate of economic growth and, accordingly, nominal GDP is more restrained than the NBU's forecast. At the same time, budget revenues and expenditures remain sensitive to the course of military events and other potential shocks.
The state budget deficit is planned to be almost entirely financed by international assistance, so the need for external financing will remain significant. At the same time, uncertainty about the amount of aid has been significantly reduced thanks to the ERA Loans mechanism.
In addition, the amount of net domestic borrowing planned for 2025 is very moderate, reflecting a prudent approach to the domestic debt market and the burden on debt service expenditures. There is still room to attract additional resources in the event of unforeseen events.