The Board of the National Bank of Ukraine has decided to cut the key policy rate from 8% to 6% effective 12 June 2020. This is the lowest level of the key policy rate since Ukraine gained its independence.
Consumer and investment demand is most likely to remain subdued for longer than forecast in April. On the one hand, this will keep inflation below the target level for longer than projected in the April forecast. On the other hand, this means that the Ukrainian economy will face a deeper contraction than expected. This requires the central bank to continue its monetary policy easing in order to support the economy as the country gradually lifts quarantine measures.
Inflation in April–May hovered around 2%, being lower than expected and below the target range of 5% ± 1 pp.
Inflationary pressures remained weak primarily due to a significant drop in consumer demand for food and nonessential goods. Moreover, price growth was restrained by lower energy prices, increased supply of vegetables, and frozen prices for many services during the quarantine. These factors offset the effects of the hryvnia’s weakening in March and the sustained high demand for some goods in early April – these effects having completely vanished as of now.
Further on, inflation will grow moderately, albeit likely heading towards the target range more slowly than expected.
First, consumer and investment demand remain subdued, although business activity has started to pick up gradually as the quarantine restrictions are eased. The fiscal and monetary policy measures taken with the aim of supporting businesses and households will only partially offset the decline in consumer demand. The recovery of consumer demand will be gradual even after the quarantine is lifted.
Second, the FX market, which has a major impact on the price of the basket of goods, is favorable for low inflation. Since the start of April, the supply of foreign currency on the interbank market has exceeded demand. Imports of goods remain below pre-crisis levels across almost all categories of goods, while exports are declining more slowly. As a result, the hryvnia strengthened and since early April the NBU has used this opportunity to purchase around USD 1.8 billion in order to increase international reserves. In such a way, the NBU has become a net buyer of foreign currency since the start of the year, having compensated for the outflow of foreign currency from international reserves in March due to high demand for foreign currency.
Third, inflation expectations are improving among households and financial analysts. According to the NBU, their current expectations of inflation in 12 months have aligned with the NBU’s medium-term target.
At the same time, the NBU’s key assumption of continuing cooperation with the International Monetary Fund has realized.
On 9 June, the IMF Executive Board approved a new cooperation program with Ukraine – an 18-month Stand-By Arrangement amounting to USD 5 billion. The first tranche of USD 2.1 billion will be received today. This has provided Ukraine with access to financing from the World Bank and the EU, which has already disbursed EUR 500 million to the Ukrainian government. This year, the total amount of official financing is expected to reach over USD 5 billion, with more than half of that amount received from the IMF.
These funds would fully finance budget expenditures on counteracting the negative effects from the coronavirus pandemic and quarantine restrictions. In addition, they would increase international reserves, despite there being significant repayments of external public debt this year. A program with the IMF would also facilitate Ukraine's access to the international capital markets.
A longer-lasting coronavirus pandemic and the quarantine measures required to overcome it, both in Ukraine and globally, remain the key risk to macrofinancial stability.
In addition, it is critically important to continue structural reforms and to maintain a prudent macroeconomic policy.
Given the expectation that inflation would be below its target for a longer period of time, the NBU Board cut the key policy rate by 2 pp, to 6%. Overall, the key policy rate has decreased by 7.5 pp since the start of the current year, hitting a historic low in independent Ukraine.
Monetary easing and other anti-crisis measures taken by the NBU in recent months will support business activity in the country. Although the contraction has already bottomed out, the NBU estimates that the extent of the recession in Q2 will be greater than expected. Therefore, measures to put the economy back on the track to growth need to be rather decisive.
The NBU has also decided to narrow its interest rate band on standing facilities, from the key policy rate +/- 2 pp to the key policy rate +/- 1 pp.
This means that with the new key policy rate, overnight refinancing loans will be issued at 7%, and overnight certificates of deposit will be placed at 5%.
By changing the width of the band, the NBU will be able to achieve the operational goal of its monetary policy, which is to keep hryvnia interbank rates close to the key policy rate, and within the band of interest rates on standing facilities.
A decrease in the key policy rate below its neutral level indicates the end of the cycle of rapid monetary policy easing.
Given the high level of uncertainty, the NBU’s future monetary policy will mainly depend on:
- how great is the fall in consumer demand, which weakens inflationary pressures
- on the other hand, it will be driven by the speed of the recovery of business activity on the back of relaxed quarantine measures, which will accelerate price growth.
The decision to cut the key policy rate, to 6%, was approved by NBU Board Decision on the key policy rate No.397D, dated 11 June 2020.
A summary of the discussion by Monetary Policy Committee members that preceded the approval of this decision will be published on 22 June 2020.
The next meeting of the NBU Board on monetary policy issues will be held on 23 July 2020 as scheduled.