Summary of Key Policy Rate Discussion by NBU Monetary Policy Committee on 5 March 2025

Meeting date: 5 March 2025.

Attendees: all 11 members of the Monetary Policy Committee (MPC) of the National Bank of Ukraine:

• Andriy Pyshnyy, Governor of the National Bank of Ukraine
• Kateryna Rozhkova, First Deputy Governor
• Yuriy Heletiy, Deputy Governor
• Yaroslav Matuzka, Deputy Governor
• Sergiy Nikolaychuk, Deputy Governor
• Dmytro Oliinyk, Deputy Governor
• Oleksii Shaban, Deputy Governor
• Pervin Dadashova, Director, Financial Stability Department
• Volodymyr Lepushynskyi, Director, Monetary Policy and Economic Analysis Department
• Oleksandr Arseniuk, Acting Director, Open Market Operations Department
• Yuriy Polovniov, Director, Statistics and Reporting Department.

The MPC members discussed the key drivers of inflation, the risks of it remaining high for long, and the NBU’s measures that minimize these risks and are intended to put inflation back on a sustainable downward-sloping trajectory leading to the regulator’s 5% target

At the beginning of the year, consumer inflation continued to grow in annual terms, to 12.9% in January, as expected, the discussion participants said. The NBU’s early estimates show inflation continuing to accelerate in February. At the same time, core inflation (11.7% yoy in January) edged above the forecast as impact from fundamentals intensified. This was partially due to the further growth in businesses’ production costs, including those of labor and energy, as well as the persistence of fairly strong consumer demand. High growth rates of services prices remained an indication of significant domestic price pressures.

Although economic agents’ inflation expectations remained under control, their movements were mixed. Specifically, financial analysts revised their inflation projections marginally higher, while households’ inflation expectations actually improved, including due to the hryvnia gaining strength in February. However, people continued to watch inflation closely, according to data from their online search queries. Given a potentially long-lasting period of accelerated inflation, this could adversely affect inflation expectations and make price pressures more persistent.

Overall, the balance of risks to inflation developments remained skewed to the upside. On the one hand, the situation in the FX market improved, inflation and exchange rate expectations remained sustainable, and the probability of shortfalls in international financing declined, considering the disbursements anticipated under the Ukraine Facility and ERA Loans. On the other hand, fundamentals are having a stronger impact, and geopolitical risks have risen significantly. In addition, russian aggression is doing increasingly more damage to Ukraine’s energy sector. For instance, russian attacks on gas infrastructure are further exacerbating the risk that an economic slowdown and a spike in inflationary pressure occur simultaneously. Other war-driven risks remain relevant, including potential additional budget needs to shore up Ukraine’s defenses.

Given that inflation is in the double digits and the balance of risks to its further developments is shifted upwards, it is feasible for the NBU to take more steps to restrain price pressures and minimize the likelihood of an unanchoring of inflation expectations.

Seven MPC members called for increasing the key policy rate by 1 pp, to 15.5% in March

A further uptick in inflation and a stronger impact from fundamentals are threatening to entrench inflation at high levels, these discussion participants said. Accordingly, the NBU must act with resolve and reaffirm its commitment to its mandate to ensure price stability in order to maintain confidence in monetary policy.

The 1 pp hike in the key policy rate in March corresponds to the trajectory of the January macro forecast’s baseline scenario and, surveys show, to the expectations of most financial market participants. Along with increasing the effectiveness of interest rate policy’s operational design (more on this below), such a step will help deal with the current price surge and maintain macrofinancial resilience in wartime.

One of these MPC members said that the NBU should not take a wait-and-see approach of relying solely on the hope that the factors behind the price pressures are temporary and on track to die down this summer. Underlying price pressures may prove more persistent than anticipated, this participant said. The continuous presence of a significant shortage of workers in the labor market is fueling rapid wage increases, which are outpacing the NBU’s previous estimates. This, in turn, is putting pressure on prices through rising production costs as well as through the channel of still-strong consumer demand. Vigorous lending, among other things, is pointing to sustained consumer demand, which has hardly responded at all to the NBU’s previous action to tighten interest rate policy.

Another MPC member said that inflation has been in double-digit territory since the end of last year and that it is likely to continue to rise in the coming months. Such a high rate of inflation, which has already affected more than half of the consumer basket, exceeds the threshold level of attention (more in the NBU’s October 2024 Inflation Report). This is posing significant risks that inflation expectations may worsen, dampening the population’s appetite for hryvnia savings, an outcome that may propel inflation through a wage-price spiral.

Yet another participant said that the further destruction of Ukraine’s energy infrastructure could be a significant and underestimated risk of more intense inflationary pressure. On the one hand, Ukraine lived through the winter with a smaller-than-expected electricity deficit. On the other, russia caused significant damage to Ukraine’s gas infrastructure. As a result, a decrease in gas extraction is possible in 2025, likely leading to higher imports, increased production costs, and additional pressure on prices through the production costs channel. In the medium term, this may also compound the need to revise administered prices.

Several MPC members said there are a number of external risks that, if materialized, could have a significant impact on inflation developments in Ukraine. One of those risks is rising geopolitical uncertainty over how to stop russian aggression in a manner that is fair to Ukraine. An additional risk to domestic price developments is elevated uncertainty in global commodity markets over the possibility of the U.S. imposing restrictions on free trade and prompting other countries to respond in kind, a scenario where multiple trade wars erupt and escalate.

Another participant said that if the status quo were to be maintained or if the NBU took indecisive action, there would be a risk of the ex-post real key policy rate moving into negative territory in the months ahead. This could call into question the NBU’s goal of protecting hryvnia savings from losing value to inflation, and adversely affect confidence in the central bank.

Another MPC member concurred, saying that amid a rising intensity of fundamentals’ impact on inflation and a threat of its protracted entrenchment at high levels, the lack of an adequate response by the NBU could undermine monetary policy’s credibility and undo the regulator’s previous achievements in ensuring price stability. The NBU’s ability to maintain macrofinancial resilience in wartime depends directly and primarily on the level of policy credibility.

The participants also discussed the potential effect on lending from a further tightening of interest rate policy. Most MPC members concluded that this impact will be moderate, given the revival of competition between banks for quality borrowers, progress implementing the Lending Development Strategy, and a significant liquidity surplus.

Four MPC members favored raising the key policy rate by 0.5 pp, to 15% in March

These participants agreed on the need to tighten interest rate policy in view of an inflation pickup that is close to the forecast trajectory and due to the risks of inflation getting stuck at rather high levels, especially if adverse geopolitical scenarios take place. However, these MPC members said, a 0.5 pp hike in the key policy rate is currently large enough, considering an expected waning of the temporary drivers of price pressures and an anticipated reversal of the inflation uptrend in mid-2025. This means that the NBU has more wiggle room to balance between ensuring the controllability of inflation processes and supporting the economic recovery of Ukraine, they said.

In particular, price pressures, as measured by monthly increases in (both headline and core) consumer inflation, are subsiding, and inflation developments are close to the NBU’s forecast trajectory, only slightly surpassing it in terms of core CPI. Despite the continual heightened focus on inflation issues, economic agents’ inflation expectations remain relatively sustainable. Surveys show households’ inflation expectations for the next 12 months improving significantly in January–February (to 9.9%, down from 11.3%). Analysts and banks are expecting inflation to slow to the single digits this year. This reinforces confidence in a reversal of price developments, going forward, and reduces the need for a significant tightening of interest rate policy.

Another MPC member said that the stabilization of the FX market situation and the NBU’s ample capability to maintain the sustainability of this market could also be an argument in favor of a more moderate increase in the key policy rate. The current volume of international reserves continues to be significant. The likelihood of receiving larger volumes of external financing this year than projected in the January macro forecast has increased. Exchange rate fluctuations and the preservation of a high level of international reserves are having a positive impact on exchange rate and inflation expectations and confidence in hryvnia instruments. Specifically, despite substantial repayments, the portfolio of hryvnia domestic government debt securities held by households kept making positive gains in January–February. Retail term deposit inflows continued as well, even in seasonally adjusted terms. This contributed to a significant slump in people’s demand for cash and cashless foreign exchange, to less than USD 1 billion in February.

Stabilizing the exchange rate developments will probably alleviate price pressures from the exchange rate factor, this MPC member said. This will happen both directly (through goods with a large share of imports in production costs and through merchandise that is heavily dependent on external prices) and indirectly through the expectations channel. All of this reduces the need for a bigger increase in the key policy rate.

Another MPC member said that a 0.5 pp hike would be quite enough to keep the real key policy rate in positive territory in the coming months. Such a decision, accompanied by appropriate forward guidance that clearly states the NBU’s readiness to respond as needed to mounting threats to price stability, will send a comprehensive signal to the market, this participant said. In addition, the more moderate increase in the key policy rate will have a limited impact on lending, an outcome that is important in an environment where the relatively rapid economic recovery from war shocks has lost some of its initial momentum.

The vast majority of MPC members called for adjusting the operational design of interest rate policy to ramp up competition between banks for depositors and to continue to adequately protect hryvnia savings from inflation

At the outset of the discussion, several MPC members said that in response to previous steps to raise the key policy rate, yields on domestic government debt securities have increased and currently remain sufficient in real terms to maintain demand for this instrument. However, transmission to deposit rates has been less than sufficient, and so there is a need for additional measures.

On the one hand, the NBU’s policy reversal made it possible to stop the decline in bank deposit rates, as expected. On the other hand, monetary transmission is considerably constrained by a large liquidity surplus in the banking system, high uncertainty, and significant market concentration. In particular, some of the banks continue to enjoy non-competitive advantages from the concentration of excess liquidity, including through the uneven redistribution of significant military allowances and social benefits. Such banks are holding back from revising their interest rate policies and are ignoring the NBU’s actions in this regard, a behavior that is also resulting in an extremely restrained pace of growth in average rates on deposits across the banking system.

Given this course of events, most MPC members called for calibrating the operational design of interest rate policy to create additional incentives for banks to compete for depositors and increase the volume of hryvnia retail term deposits. The fastest way to achieve this is to strengthen the effectiveness of three-month certificates of deposit (CDs) that carry an increased interest rate and are tied to how successfully banks draw in term deposits from households, these participants said. In 2023, this tool proved effective, but last year its impact was expected to decline as its parameters changed amid an easing cycle of interest rate policy. Specifically, the NBU gradually narrowed the ability of banks to invest in three-month CDs and reduced the spread between rates on three-month and overnight CDs. It is now appropriate to restore some of these incentives for banks in order to shore up monetary transmission to deposit rates, these MPC members said.

Several other participants said that the NBU has already taken sufficient measures to preserve the appeal of hryvnia instruments, both by increasing the key policy rate and by maintaining the sustainability of the FX market. Yields on domestic government debt securities and rates on hryvnia deposits at many private banks currently provide an adequate level of protection against inflation. No outflows of hryvnia deposits are taking place, meaning there is no need for the NBU to again revise the operational design of interest rate policy. Considering the lag in monetary transmission and a likely reversal of the inflation uptrend as soon as the middle of the year, such a step may be excessive.

Such changes may prove ineffective due to the difficulty of making term deposit portfolios grow rapidly under current conditions and banks’ expectations that the interest rate tightening cycle is short-lived, one of these MPC members said. A sluggish response from banks that enjoy significant liquidity and cheaper funding amid sustainable current account balances is also likely.

However, most MPC members upheld the proposal to revise the operational design parameters, starting 4 April, to preserve the real yields on term deposits, taking into account additional taxation. The NBU should be committed to safeguard hryvnia savings from inflation and to use all available instruments for this purpose as declared, not just the key policy rate, these MPC members said.

Although households are taking a growing interest in domestic government debt securities, deposits remain a more popular and accessible savings instrument that can restrain pressures on prices and international reserves, one of these MPC members said. At the same time, inflows of hryvnia retail term deposits, though slightly higher in recent months, remain lower in year-over-year terms. Term deposits as a share of the total volume of hryvnia retail deposits have been steadily shrinking. This indicates the need to make bank deposits more attractive. The NBU should act decisively enough that monetary transmission grows in strength in order to support people’s appetite for term deposits, particularly because of the risks of protracted high inflation with an adverse impact on expectations. Neglecting to properly protect hryvnia instruments against inflation will aggravate the risk of loss of confidence in hryvnia savings, increase the demand for foreign exchange, and put more pressure on international reserves, this MPC member said.

Another MPC member said that although the banking system has significant liquidity and some of the market-maker banks wield non-market advantages, changes in operational design will give banks, primarily private ones, incentives to compete for depositors. Privately owned banks currently generate the lion’s share of hryvnia retail term deposit inflows. Aggressive price competition between these banks is enabling them to continue to win back a significant market share from banks with more passive interest rate policies. Private banks are therefore expected to remain the main conduit of monetary transmission to deposit rates, and their competitors will be forced to respond.

Most MPC members agreed that now is the right time for the NBU to amplify the incentives embedded in operations with three-month CDs. These MPC members supported widening the interest rate spread between overnight and three-month CDs from 2.5 pp to 3.5 pp, as well as expanding banks’ capabilities to conduct operations with three-month CDs by increasing (from 3.0 to 3.5) the multiplier of retail term deposit gains that goes into the calculation of the limits for investments in this instrument. These changes to the operational design should revive price competition and thus the population’s demand for hryvnia instruments, these MPC members said. As a result, part of demand will shift away from consumption and FX purchases and toward hryvnia savings. This will help ease pressure on the FX market, save international reserves, and slow inflation more sustainably.

The set of measures taken by the NBU will be sufficient to overcome the price surge, but there may still be a need for a tighter monetary policy throughout 2025 than projected in the January forecast, the MPC members said

The measures taken since December 2024 to tighten the NBU’s interest rate policy should suffice to reverse the inflationary uptrend, most participants said. After the price surge has peaked and the risks of inflation becoming entrenched in the double digits have moderated, the NBU will be able to return to the easing cycle of interest rate policy this year, they said.

However, most MPC members also said that, because the balance of inflation risks is shifted upward, the NBU should be prepared to hold the key policy rate at the current level for longer or even to further tighten interest rate policy if risks to price developments and inflation expectations materialize or intensify.