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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 the key policy rate at 25% per annum and take a number of additional measures to spur competition among the banks for retail term deposits. Such steps will contribute to the attractiveness of hryvnia savings improving further and to supporting stability on the FX market, and will create preconditions for FX restrictions to be eased. This will help protect households’ savings from inflation and will secure a decline in the pressure on prices.

At the start of 2023, inflation has been declining more rapidly than the NBU expected but is still high

Inflation in Ukraine decelerated for the second month in a row, to 24.9% yoy in February. The decline in inflation started earlier and was faster than forecast by the NBU. This was facilitated, among other things, by an increase in supply of foods and fuel, a fast-paced recovery in the energy system after russia’s attacks, and weaker consumer demand. Fixed official exchange rate of the hryvnia and frozen utility tariffs were also important factors restraining the rise in consumer prices. Measures taken previously by the NBU, including maintaining the key policy rate at 25%, raising required reserve ratios, introducing new deposit products, and calibrating FX restrictions contributed to the strengthening of the hryvnia in the cash segment of the market. This improved inflation and exchange rate expectations, in particular. The complete cessation of monetary financing of the budget from the start of the year was also a favorable factor.

In spite of this, inflation remains high and pressures from business costs are persistently strong. Some factors that have been restraining inflation in several past months may be temporary. For example, an increase in food supply and faster stabilization of the fuel market largely owed to the mild winter.

Inflation will continue to slow, including due to the NBU’s measures to improve the attractiveness of hryvnia assets and support exchange rate stability

The attractiveness of hryvnia term deposits improving further on the back of lower pressures in the cash segment of the FX market will prompt depositors to increase their savings in the domestic currency. This will make the FX market more resilient and protect international reserves, supporting an improvement in exchange rate and inflation expectations going forward. A slowdown in global inflation, including the decline in energy prices, and the high base effect of the first year of the full-scale war will also contribute to a drop in the inflationary pressure. Relatively moderate consumer demand will also curb price growth.

At the same time, the duration and the intensity of hostilities and further destruction of critical infrastructure remain important risks to the inflation dynamics. The risks of the following are also relevant:

  • additional budgetary needs and substantial quasi-fiscal deficits in the energy sector
  • complicated or blocked operation of the grain corridor
  • early monetary policy easing by leading central banks in response to rising threats to financial stability, which might lead to slower global disinflation and higher volatility on global financial markets.

Regular inflows of international financing, including the financing under the anticipated new IMF program, are an important precondition for macrofinancial stability

International financial assistance will remain the main source for covering deficits of the state budget and the balance of payments. The larger share of financing needed for this year has already been approved by international partners. Moreover, the IMF’s Extended Fund Facility is expected to be launched in the near future. Taking into account potential inflows of financing from international partners, including the IMF, and further revival of the domestic debt market, budget needs will be fully covered in 2023 without resorting to monetary financing of the budget deficit. In turn, the NBU will be able to continue maintaining sufficiently high international reserves and balance the FX market.

With a view to bringing down inflation further, protecting hryvnia savings from being eroded away by inflation, and maintaining a stable exchange rate, the NBU Board decided to keep the key policy rate at 25%. It also decided to introduce additional measures to boost competition among the banks for household time deposits.

Interest rates on hryvnia time deposits continue to rise, driven, among other things, by the central bank’s previous measures. The banks that took the lead in raising their interest rates in recent months were able to improve the term structure of their deposits. That said, the largest banks, which among other things enjoy noncompetitive advantages in obtaining liquidity, still have interest rates that are not attractive enough to depositors given the high current and expected inflation. As a result, a substantial portion of household funds are being kept in current accounts. This is generating additional risks to macrofinancial stability, especially if administrative restrictions are eased further.

In order to minimize the above risks, the NBU Board decided, starting from 7 April 2023, to adjust the operational design of monetary policy through:

  • introducing three-month certificates of deposit with a fixed rate that equals the key policy rate. The banks’ ability to invest in these CDs will depend on the volumes of their hryvnia household deposits with initial maturities from three months, as well as on how successful the banks are in increasing their volumes of these deposits. The first quantitative tender to place CDs with maturities of up to three months is scheduled to be held on 7 April 2023. More detailed terms and conditions for participating in this tender will be announced to the banks before 6 April 2023. The NBU intends to use this instrument for at least one year.
  • cutting the interest rate on overnight certificates of deposit, to 20%.

What is more, the NBU declared that, starting from 11 May 2023, preferential required reserve ratios for hryvnia (0%) and FX (10%) time household deposits will only apply to deposits with initial maturities from three months.

The above measures will bolster the market stimuli that encourage the banks to raise hryvnia time household deposits, which will decrease risks to the FX market and international reserves as FX restrictions are eased. In particular, these measures will help:

  • ensure continued growth in interest rates on time deposits, thus more strongly protecting hryvnia household savings from being eroded away by inflation
  • develop the culture of making hryvnia savings
  • encourage the banks to step up their activity on the interbank market and
  • boost the status of the key policy rate as an effective instrument that has a significant impact on the money market and the business behavior of economic agents.

The NBU will continue to deliver the monetary conditions required for a steady drop in inflation, improving inflation expectations, and supporting exchange rate sustainability.

If required, the NBU will adjust monetary conditions, taking into account the balance of risks and any changes in the macroeconomic forecast, in order to safeguard price and exchange rate stability, while also laying the foundations for a gradual easing in FX restrictions.

When the financial system and the economy start functioning normally, the NBU will gradually return to the operation design of monetary policy which was in place before the full-scale invasion, and which is used by countries that target 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. 101, dated 16 March 2023, which will come into effect on 17 March 2023.

A summary of the discussion by Monetary Policy Committee members that preceded the approval of this decision will be published on 27 March 2023. 

The next meeting of the NBU Board on monetary policy issues will be held on 27 April 2023, according to the confirmed and published schedule.

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