The Board of the National Bank of Ukraine has decided to raise the key policy rate to 10% per annum. As many of the pro-inflationary risks have materialized, tighter monetary policy is needed in order to improve inflation expectations and ensure steady disinflation toward the target of 5%.
Inflation declined at the end of the year thanks to the record-high harvest and a correction of some global food prices, the strengthening of the hryvnia in the previous months, the vanished low base effect, and monetary policy tightening. Inflation was also restrained by administrative decisions to fix tariffs on some utility services. As a result, consumer inflation slowed from a peak of 11% in September to 10% in December.
At the same time, a faster disinflation was prevented by a further increase in global energy prices, which passed through to prices of goods and services, and by pressures from other production costs, including labor costs. Robust consumer demand also continued to play a role. In particular, this spurred core inflation further, to 7.9% as of the end of the year.
The NBU has downgraded its 2022 inflation forecast, from 5% to 7.7%, considering the materialization of a number of pro-inflationary factors.
In particular, global energy prices will remain high for longer than expected. Not only will it put pressure on businesses’ production costs, but will also require at least a gradual correction of utility tariffs. Price pressures from trading partner countries, in which inflation is only approaching its peak, will remain strong. Second-round effects from businesses’ larger raw material expenses and labor costs will persist. An increase in demand for Ukrainian labor force, both inside the country and abroad, and qualification mismatches on the labor market will impact the growth in wages more than expected. With household income rising, consumer demand will remain robust, which will also restrain disinflation.
Moreover, a deterioration in the information environment amid geopolitical tensions that occurred late last year affected the sentiment of various groups of economic agents, putting a depreciation pressure on the hryvnia. Through exchange rate and expectations channels, this will create additional pressures on prices in the coming months.
Monetary policy tightening by the NBU, a correction of global commodity prices, and the influence of last year’s bumper crops will foster a gradual disinflation. It will be additionally driven by the easing of the global inflation surge and the waning effects of the pandemic, reflected, among other things in a larger correction of prices for raw materials, food, and logistical services.
The NBU tightening its monetary policy will also contribute to a decline in the underlying inflationary pressure. Core inflation is expected to slow to 4% in the coming years, with the administrative component making the largest contribution to the increase in consumer basket prices.
At the same time, inflation will be quite volatile in 2022 due to base effects. In addition, like in many other countries, the rise in inflation in Ukraine will last longer than expected. Taking into account the strong pro-inflationary factors and the need to continue supporting the post-pandemic economic recovery, inflation is projected to return to the target range of 5%±1 pp in mid-2023, given the monetary conditions envisaged under the baseline scenario.