Inflation in Ukraine is likely to accelerate through 2024 as the economy slows, ICU predicts

Inflation in Ukraine is expected to accelerate to 7.8 percent in 2024, compared to the 6.4 percent previously forecast. Economic growth is expected to be 4 percent, slightly lower than the 4.1 percent forecast in April. The likelihood of limited monetary financing of the budget deficit has also increased, according to updates to the macroeconomic forecast of the ICU investment group.

“Annual inflation began to rise predictably from May, slightly exceeding our expectations. We forecast that inflation will be in the range of 7-8% by the end of the year. It is likely to accelerate further in the first quarter of 2025, but will remain in single digits,” commented Vitaliy Vavrishchuk, Head of the Macroeconomic Research Department at the ICU.

The group estimates that inflation will be around 8 percent in 2025.

ICU analysts believe that the National Bank of Ukraine (NBU) would have had room for a more significant reduction in the key interest rate in the first half of 2024. However, given the current acceleration of inflation and the period of sharp fluctuations in the foreign exchange market, a pause in rate cuts is now inevitable.

“An easing of monetary policy in the coming months appears unlikely,” the report emphasizes.

While the ICU predicted a cut in the key interest rate to 11.5% in its April forecast, it is currently expected to remain at 13% and only fall to 11.0% annually next year.

The group points out that it expects economic growth to slow in the second half of 2024 due to power supply problems, labor shortages and declining crop yields.

“Nevertheless, we expect economic growth of around 4.0% for the current year. The main growth drivers are private domestic consumption and the recovery of exports due to the operation of the maritime transport corridor,” explains Vavrishchuk. He believes that the role of government consumption in supporting economic growth will be positive, but less significant than in 2023.

For 2025, the ICU forecasts unchanged GDP growth of 4%. In the updated forecast, the nominal GDP estimate for this year was reduced from $190 billion to $188 billion. Next year, it is expected to be $195 billion.

Overall, the ICU considers macro risks to be manageable, despite their increase in recent months. The group believes that significant inflows of international financial assistance provide sufficient security to the foreign exchange market and provide the government budget with the necessary resources.

“The external political risks associated with a possible rise in power of less friendly governments in partner countries could be largely mitigated by the $50 billion financial assistance package that the G7 countries are currently negotiating,” argues Vavrishchuk.

The second biggest source of risk for the economy is the expected power supply disruptions in autumn and winter, while the complex security situation remains the main risk, the forecast says.

Vavrishchuk stresses that the situation on foreign accounts has remained virtually unchanged over the past two and a half years: a large trade deficit continues to exist and private capital outflows have occurred. At the same time, he notes, these capital outflows are fully offset by international financial assistance, and this situation is likely to continue in the foreseeable future.

The group raised its forecast for the current account deficit to 5.6 percent of GDP in the latest forecast from 7.8 percent of GDP in April, but expects it to rise to 9.5 percent of GDP next year.

“Inflows of external financial assistance will be at least 60% higher in the second half of the year than in the first half. If all the planned assistance arrives on time, the NBU's reserves could exceed $43 billion by the end of 2024, which would be higher than at the end of 2023. This level would be comfortable and would allow the NBU to maintain full control over the foreign exchange market,” the document says.

According to the forecast, Ukraine's international reserves are expected to amount to $43.7 billion, down from $44.7 billion in April, and a further decline to $37.5 billion is expected in 2025.

Vavrishchuk notes that the foreign exchange market continues to operate with a significant deficit, which has increased noticeably in recent months.

“The NBU's exchange rate smoothing mechanism does not always work perfectly, so there are occasional moderate turbulences in the market. However, in general, the NBU is moving in the right direction and is gradually weakening the hryvnia,” he explained.

ICU has lowered its year-end exchange rate forecast by 30 kopecks to 42.6 UAH/$1 compared to the previous forecast.

The main challenge in the second half of the year will be financing the state budget deficit, as defense spending may exceed the current plan by almost UAH 500 billion, the analyst notes.

He believes that a significant part of these expenses can be covered by additional tax revenues, but more than UAH 200 billion would have to be raised on the domestic credit market.

“Therefore, in our opinion, the likelihood of a scenario of limited monetary financing of the budget deficit at the end of the year is gradually increasing,” Vavrishchuk concluded.