- National Bank of Ukraine
- Monetary Policy
- Monetary Policy Instruments
Test policy
Under the regime of flexible inflation targeting, the NBU ensures that inflation is brought to the 5% target within a policy horizon of three years at most, by applying a consistent combination of interest-rate and exchange-rate policy instruments, FX restrictions, and other tools as necessary.
By changing the key policy rate and other rates for its transactions with the banks, the NBU shapes the conditions under which the banks make deals with each other in the money market, and thus changes the cost of short-term lending.
Through the mechanism of capital flows between different sectors of the financial market, the cost of short-term lending affects the banks’ interest rates for loan and deposit transactions with businesses and households, the exchange rate of the hryvnia, and the prices of other short-, medium-, and long-term financial instruments. As a result, by modifying interest rates, the NBU influences macroeconomic indicators such as inflation and GDP.
The key policy rate is the NBU’s primary interest rate. This is the main benchmark for the value of money and an indicator of current and future changes in monetary policy. The key policy rate has the greatest impact on the behavioral motives and expectations of economic agents.
The full-scale invasion by russia has distorted Ukraine’s economic environment and significantly weakened its monetary transmission channels. Among other things, this made it impossible to conventionally use the key policy rate as the main instrument of monetary policy. However, as the economy adjusted to wartime conditions and the NBU took a number of measures, the effectiveness and predictability of the key policy rate’s impact on market rates gradually recovered. This became one of the prerequisites for the transition to a flexible inflation targeting regime.
Although the key policy rate is currently not the main tool, it does remain an important instrument that in a coordinated combination with other tools contributes to achieving the NBU’s strategic goal of ensuring price stability and fulfilling tactical tasks. Those include protecting hryvnia savings from losing value to inflation and ensuring stable and controlled conditions on the FX market.
To further restore the key policy rate’s role as the main monetary instrument, the NBU is constantly working to shore up the effectiveness of monetary policy transmission channels
The NBU shapes economic agents’ expectations and motives (and hence macroeconomic indicator developments) not only through the size and direction of changes to the key policy rate and other interest rates for its operations. Forward guidance and the NBU’s key policy rate forecast are also important.
Specifically, the NBU shapes the expectations of target audiences by publishing, in its press releases about decisions on the size of the key policy rate, appropriate forward guidance regarding further changes in monetary policy.
In addition, a brief account of perspectives on the key policy rate’s further developments is regularly published in the Summary of Key Policy Rate Discussion by NBU Monetary Policy Committee.
The operational goal of the NBU’s interest rate policy is to maintain hryvnia short-term interbank rates at a level close to but no lower than the key policy rate. For interest rate policy purposes, the Ukrainian OverNight Index Average (UONIA) is used as an indicator of the cost of short-term hryvnia funding on Ukraine’s interbank market.
Merely changing the level of the key policy rate and other interest rates or forward guidance is not sufficient to achieve the operational goal of monetary policy. The key to success is the NBU’s operations to provide and withdraw bank liquidity at the key policy rate and interest rates close to it.
The scope, mechanism, and duration of such operations, the specifics of banks’ access, and many other parameters, along with the NBU’s range of interest rates, constitute the operational design of interest rate policy, which ensures policy effectiveness.
Standing facilities – daily operations to provide and withdraw the liquidity of banks – make up an important element of the operational design of interest rate policy. Ukrainian banks have the opportunity to freely take out overnight loans or purchase overnight certificates of deposit on business days.
Given the banking system’s considerable surplus of liquidity, to build the operational design of interest rate policy, the NBU currently uses a floor system whereby the rate on overnight certificates of deposit is equated to the key policy rate, as these are core liquidity regulation operations.
Liquidity-providing or liquidity-absorbing operations with maturities longer than overnight are conducted on the basis of quantitative or interest rate tenders on a pre-announced schedule and, if necessary, on an ad-hoc basis. Certificates of deposit are traded only among banks and can also be used as collateral against NBU loans.
For instance, to ensure the desired developments of rates on term hryvnia instruments in wartime, the NBU introduced and is currently conducting transactions with three-month CDs. The rate on such transactions is slightly higher than the key policy rate, and banks’ access to such CDs is limited by being tied to the growth in banks’ portfolios of hryvnia retail term deposits. As a result, this element of operational design helps maintain a sufficient return on hryvnia term deposits and thus drive demand for them.
Considering the still limited capacity of the key policy rate to fully play the role of the main monetary policy instrument, FX interventions objectively remain an important means of fulfilling the NBU’s tasks and goals.
In addition, russia’s full-scale invasion distorted economic processes and the financing of the budget deficit, which also led to significant changes in the functioning of the Ukrainian FX market. On the one hand, there currently is, and will likely continue to be for quite some time, a significant structural deficit of foreign exchange in the private sector. On the other hand, international reserves are replenished to a sufficient extent, thanks to significant amounts of assistance from international partners that does not directly enter the FX market.
Under such conditions, from one perspective, the NBU’s role objectively increases: the central bank ensures that part of international aid is flowing into the FX market to fuel the supply of foreign exchange and maintain stable and controlled market conditions. From another perspective, the NBU is taking steps towards a gradual strengthening of the exchange rate’s role as an adjustment mechanism for Ukraine’s economy in order to increase its ability to adapt to changes in internal and external conditions.
With this in mind, the NBU uses managed flexibility of the exchange rate as a transitional regime on the way back to a floating exchange rate. By conducting FX interventions under this regime, the NBU covers the war-induced structural deficit of foreign exchange in the private sector and smooths out excessive exchange rate fluctuations.
The NBU’s active presence in the FX market makes it possible to avoid extreme exchange rate fluctuations, which is important for the sustainability of exchange rate and inflation expectations, the proper transmission of the key policy rate, and the protection of international reserves, as well as for ensuring price and financial stability and sustainable economic growth. At the same time, moderate exchange rate fluctuations in response to seasonal and ad-hoc changes in market conditions contribute to economic agents’ awareness of FX risks and the activation and development of the FX market, and reduce the risk that imbalances in foreign trade may accumulate.
To achieve intended synergy effects, the NBU calibrates the parameters of its FX interventions, aligning them with the parameters of interest rate policy and settings of FX restrictions.
The russian full-scale war against Ukraine forced the NBU to impose a number of administrative restrictions on the FX market to ensure the financial system’s uninterrupted operation and the economy’s adjustment to wartime conditions.
Some of these restrictions were put into place to prevent panic at the outset of russia’s invasion and have already been lifted. However, some of the restrictions are still in effect in order to mitigate the war’s adverse impact on the balance of payments and thus on the FX market.
But any restrictions lose their effectiveness over time and, if left in place for long, can even be harmful to the sustainability of the FX market and exchange rate expectations, as well as to the economy’s overall development. Considering the importance of minimizing FX market distortions and the need to improve the conditions for doing business in Ukraine and for entry of domestic businesses into new markets, support the economy’s recovery, and promote new investment inflows into the country, the NBU pursues a policy of gradually easing its FX restrictions.
Under the approved Strategy, restrictions are relaxed as macroeconomic prerequisites for such an easing emerge. Every step to relax the FX restrictions is carried out based on assessments of the effect of previous steps as well as its potential impact on inflation developments, the state of the FX market, international reserves, macroeconomic and financial stability, business and investment climate, and national security.
To fulfill its current monetary policy tasks, the NBU may use other tools, including: