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NBU Leaves Its Key Policy Rate Unchanged at 25%

NBU Leaves Its Key Policy Rate Unchanged at 25%

The Board of the National Bank of Ukraine has decided to keep its key policy rate at 25% per annum. Under current conditions, such level of the key policy rate is sufficient to maintain exchange rate stability and keep inflation processes under control. At the same time, in order to meet these goals, it is important to enhance monetary transmission and further improve the attractiveness of hryvnia assets, on which the NBU is currently working.

Inflation continues to grow, but the growth is somewhat slower than forecast by the NBU

In July, inflation accelerated to 22.2% yoy. According to the NBU’s preliminary estimates, it reached around 23% in August. The price growth was generally more moderate compared to the NBU’s forecast (July 2022 Inflation Report). This was mainly driven by a faster-than-expected decline in fuel prices resulting from a decrease in global oil prices and setting up logistics inside Ukraine. Prices for some vegetables also grew slower, as was expected, in particular thanks to a seasonal increase in supply, which came mostly from households. 

However, the inflationary pressure remains high. Effects of the war, in particular the destruction of production facilities and disruption of logistics, still have a major impact on prices of almost all goods and services in the consumer basket. A worsening of inflation expectations is also pushing prices up. This is reflected, among other things, in high demand for durable goods and foreign currency. The inflation dynamics were also influenced by the correction of the official exchange rate of the hryvnia in July, which was driven by the need to maintain the resilience of the economy and the financial system over a longer term.

Going forward, inflation processes will remain under control, in particular thanks to measures taken by the NBU and the government

Maintaining stability of the exchange rate remains an important precondition for stabilizing expectations and keeping inflation processes under control. A one-time correction of the hryvnia official exchange rate and additional measures taken by the NBU to ease the depreciation pressure helped reduce imbalances on the FX market. This is, in part, evidenced by lower volumes of NBU interventions to sell foreign currency in the past months. Coupled with large amounts of international financial assistance, it drove FX reserves up to USD 25.4 billion in August. Ukraine’s international reserves are sufficient to keep the exchange rate fixed at the current level, taking into account the prospects of receiving the official financing from international partners, a gradual setting up of logistics, and a respective increase in export earnings.

In the medium run, a gradual normalization of fiscal policy will help keep inflation under control. In particular, re-imposing import taxes in July increased the government’s ability to finance wartime expenses from revenues. This eased pressures on international reserves and lowered the need for NBU to provide monetary financing: monthly volumes of budget monetization decreased to UAH 30 billion in July and August, down from UAH 105 billion in June.

Fixing utility tariffs will remain and important factor in restraining inflation. Despite high global energy prices (natural gas and electricity), the prices will remain unchanged for households during the current heating season. The impact of this factor on inflation dynamics will thus be limited.

Further growth in yields on hryvnia deposits and domestic government debt securities will also put the brakes on inflation processes. The National Securities and Stock Market Commission launching the secondary market of domestic government debt securities gave a strong impetus to the growth in yields. Increased attractiveness of hryvnia savings will allow reducing demand for foreign currency and durable goods.

Progress in cooperation with international partners, including the IMF, is an important precondition for the stable functioning of the economy in wartime

By the end of the current year, Ukraine expects to receive declared official financing totaling about USD 12 billion (in the equivalent), including EUR 8 billion as macro-financial aid from the EU. Ongoing international support will enable the NBU to maintain international reserves at a sufficient level in the coming years.

Extended full-scale war against Ukraine by russia remains the key risk for Ukraine’s economic development

The speed at which the Ukrainian economy recovers and inflation returns to a slowing trajectory largely depend on when the active phase of the war ends.

Other inflationary risks have decreased in the short term since the NBU Board made its key policy rate decision in July. However, they remain significant in the long-term. Among other things:

  • the Black Sea ports opened earlier for grain exports than the NBU had envisaged in its baseline scenario of the July macroeconomic forecast. The “Grain Agreement” makes it possible to increase export earnings beyond the NBU’s forecast, which will have a positive effect on the foreign exchange market. However, the stability of sea exports remains vulnerable, particularly in the light of the latest statements made by the authorities of the aggressor country.
  • the lack of progress in reimposing excise duties on fuel and introducing additional taxes on imports is putting less pressure on prices in the short term. At the same time, in the longer term, insufficient measures to limit imports and balance public finances through raising additional tax revenues pose risks to both fiscal stability and the country’s ability to maintain control over inflation, as well as to macro-financial stability in general.
  • the implementation of new financial support initiatives by the United States will increase Ukraine’s international reserves in 2022 beyond the forecast, which will positively affect economic stability and expectations. Instead, the prospects for the non-monetary financing of the budget deficit in 2023 remain largely uncertain.
  • the still low interest rates on hryvnia domestic government debt securities at primary auctions, in particular compared to secondary market yields, are significantly limiting government borrowing. This is restraining monetary transmission, while also dampening the growth in the attractiveness of hryvnia assets, increasing the sensitivity of the FX market to situational factors and risks to financial stability in the longer term.
  • the rate of emigration remains higher than the NBU’s assumptions, threatening to reduce the labor force and to produce long-term negative effects on the labor market and economic growth after the war. 

In view of the forecast inflation dynamics and the balance of inflation risks, the NBU Board decided to keep the key policy rate unchanged, at 25%. This decision is in line with the baseline scenario of the macroeconomic forecast, which envisages keeping the key policy rate at the current level at least until Q2 2024.

At the same time, the NBU is working on measures to enhance monetary transmission and minimize the negative impact of the budget’s monetary financing on inflation and the FX market.

If required, the NBU stands ready to raise the key policy rate above its current level and to deploy additional measures to protect international reserves, as well as and to maintain control over inflation.

The decision to keep the key policy rate at 25% per annum was approved by NBU Board Decision on the key policy rate No. 450, dated 8 September 2022. 

A summary of the discussion between Monetary Policy Committee members that preceded the approval of the NBU Board’s decision will be published on 19 September 2022. 

The next monetary policy meeting of the NBU Board will be held on 20 October 2022, according to the confirmed and published schedule

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