Summary of Key Policy Rate Discussion by NBU Monetary Policy Committee on 24 April 2024

Meeting date: 24 April 2024.

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
• Oleksii Lupin, Director, Open Market Operations Department
• Yuriy Polovniov, Director, Statistics and Reporting Department.

The MPC members discussed the options for easing the interest rate policy and FX restrictions in view of the positive monetary and financial developments, specifically the extended slowdown in inflation, sustained control over the FX market situation, as well as progress made in obtaining external financing

Inflation developments continue to be significantly better than the NBU expected, the MPC members said. In March, consumer inflation slowed to 3.2% yoy, rather than remaining at the target level of 5% projected in the macro forecast made in January. Such a pullback in inflation was largely driven by factors that are hard to project, including the temporary effects from last year’s ample harvest and warm winter that ensured a greater supply of raw food products and helped ease pressure on business costs, energy expenses in particular. Core inflation was declining close to the forecast – to 4.2% yoy in March – in part due to an improvement in inflation expectations.

The FX market situation remained under control, which had a significant impact on the dynamics of inflation expectations. The regime of managed flexibility of the exchange rate allows moderate two-way fluctuations in the exchange rate. The negative balance of the NBU’s interventions shrank significantly in Q1, in part due to the measures to tighten FX supervision and because of an inflow of export earnings driven by the further expansion of export capacities via the sea corridor. Last month’s moderate weakening of the hryvnia primarily reflected the effects from the recovery in budget expenditures, which had been restrained at the beginning of the year due to delays in external financial assistance.

At the same time, significant progress has been made since mid-March in terms of external financing. Specifically, Ukraine received more than USD 9 billion from international partners in March, and EUR 1.5 billion in April in a second tranche from the EU under the Ukraine Facility program. In addition, the United States approved the long-awaited package of military and financial aid for the current year. As a result, the risk of being short of external financing in 2024 has significantly subsided, and Ukraine can count on receiving about USD 38 billion from international partners. This helps reduce pressure on state finances and strengthens the NBU’s ability to keep the FX market situation manageable going forward.

All participants in the discussion agreed that the favorable inflation developments, an overall improvement in inflation expectations, and positive news from international partners enable the NBU to press forward with its cycle of interest rate policy easing and with its measures to loosen FX restrictions without undermining to macrofinancial stability. Making further cuts to the key policy rate will support lending and economic recovery. This is especially important because according to the updated macro forecast, economic growth this year will be more restrained, partially due to the massive new wave of destruction of Ukraine’s energy infrastructure by russians. 

Eight MPC members supported lowering the key policy rate to 13.5%

These discussion participants said that such a step is well-grounded, as it takes into account both the current favorable macrofinancial developments and the persistence of risks to the FX market and price and financial stability over the forecast horizon. Such a cut is also consistent with the controlled situation in the FX market and the NBU’s plans to go ahead with FX liberalization.

According to these MPC members, all prerequisites are currently in place for taking the next step to ease the interest rate policy further, and the central bank should seize this chance to facilitate the economy’s recovery. At the same time, although the risk of not receiving sufficient international funding this year has abated significantly, the probability that additional budget needs may arise is still there. At this point, it is also difficult to assess and forecast the consequences – for the FX market and inflation – of significant damage to critical infrastructure and energy infrastructure in particular. The NBU should therefore proceed with caution as it continues its cycle of monetary policy easing, so as not to give in to the temptation of making aggressive cuts amid the positive news of recent months. The NBU’s previous decisions were moderately conservative and made it possible to ensure macrofinancial stability, which Alfred Kammer (Director of the IMF’s European Department) said is a matter of national security. It is important that the NBU remain consistent in its monetary decisions.

Some participants in the discussion also emphasized that the NBU’s interest rate policy should continue to be consistent with its exchange rate policy and steps to ease the FX restrictions. In taking such steps as the prerequisites for them are met, the NBU should follow the order of priority of relaxing the FX restrictions that are burdensome for businesses, in line with the Strategy for Easing FX Restrictions, Transitioning to Greater Flexibility of the Exchange Rate, and Returning to Inflation Targeting. FX liberalization will bolster economic recovery, but will put additional pressure on the FX market and thus on international reserves.

Under such conditions, it is important to continue to support the interest in hryvnia instruments in order to avoid an additional surge in FX demand. This is relevant, given the expected moderate acceleration of inflation in the coming months. The banks and the Ministry of Finance, for their part, have already begun to slowly revise their interest rate policies in response to the NBU’s previous decisions to lower interest rates and to the adjustment of the parameters of operations with three-month certificates of deposit (CDs). These effects have only just started to materialize, and it will be possible to fully assess them at the MPC’s meeting in June. So, for now it is better to cut the NBU’s rates at a relatively moderate pace and to analyze in detail the effects of every new step, while minding how they correlate with the effects of the NBU’s other measures.

One of the MPC members said that it is important that the NBU remain consistent and predictable. Specifically, surveys have shown that most financial analysts are projecting a decrease in the key policy rate by 0.5–1.0 pp. A more significant step will be perceived as quite unanticipated and may come off as unreasonably optimistic, because the NBU has already resumed the easing cycle of the interest rate policy much earlier than expected and is making quick progress down this track.

Three MPC members spoke in favor of cutting the key policy rate to 13%

The necessary prerequisites are in place for a more decisive reduction of the key policy rate – by 1.5 pp in April – without posing additional risks to macrofinancial stability, they said. Inflation continues to decelerate sharply. It is below the NBU’s forecast and target range. This is having a positive effect on inflation expectations, which are showing resilience to exchange rate depreciation. The downgrade of the forecast for inflation in 2024, the maintenance of control over the FX market situation, and the good news from international partners should bolster the confidence of economic agents.

A deeper cut to the key policy rate will not have an adverse impact on expectations. Nor will it lead to a significant increase in pressure on the exchange rate and international reserves, these MPC members said. The restrictions on FX transactions currently in effect in Ukraine are tighter than before the full-scale war. What is more, the differentiation of reserve requirements will continue to restrain the reduction of the interest rates on retail term deposits. Hryvnia-denominated savings instruments will protect against inflationary loss of value, meaning the demand for them will not wane significantly. In particular, despite the reduction of the key policy rate and the moderate weakening of the hryvnia, demand for FX cash has edged lower in recent months. On the other hand, the balances of hryvnia deposits and domestic government debt securities owned by households continue to grow.

One of the discussion participants said that according to the forecast, the pickup in inflation this year will be temporary and primarily driven by factors beyond the scope of the NBU’s monetary policy, including due to slightly lower expected harvests. In addition, such an acceleration will be anticipated and moderate, and thus will not lead to an imbalance of expectations. The central bank should therefore continue pursuing the flexible monetary policy and refrain from using monetary instruments in response to temporary upticks in inflation. According to this participant, with inflation and exchange rate developments being under control, there is space to increase lending support through a more significant easing of the interest rate policy in order to revive the economy within the forecast horizon.

Another participant in the discussion said that if in the updated macro forecast the NBU finds room to reduce the key policy rate to 13% during 2024, then it is not advisable to prolong such a loosening of the interest rate policy. It is better to reduce the key policy rate more boldly and narrow the spread between it and the rates for other transactions – three-month CDs and refinancing loans – to produce a faster effect.

Economic agents have demonstrated a surprisingly resilient capability to do business amid security risks, one of these MPC members said. This will continue to mitigate the impact of adverse effects from russian aggression on economic processes. On top of that, the consequences of the damage sustained by the energy sector will be moderate this year too, this MPC member said. They will not have a material impact on production volumes or exports, and therefore will not substantially affect the supply of goods and services and the volume of FX earnings. Security and energy risks are under control, this MPC member said. Should an adverse scenario materialize, the NBU will be able to reverse its monetary policy, raise the key policy rate, and tighten the FX restrictions.

The MPC members endorsed an additional reduction of the interest rates on refinancing loans and discussed potential adjustments to the parameters of three-month-CD transactions

The discussants unanimously called for narrowing the spread between the key policy rate and the rate on refinancing loans. The vast majority spoke in favor of bringing the spread down to 4 pp. On the one hand, this step would be rather symbolic, as the banking system is operating amid a liquidity surplus, and almost no transactions are taking place in the interbank credit market. On the other hand, such a narrowing would be consistent with the gradual normalization of the operational design of monetary policy and its overall easing.

Several discussion participants proposed to consider at the meeting in June an additional reduction in the spread between the key policy rate and the rate on three-month CDs. The gradual narrowing of the spread will have a low-key impact on deposit rates because most of the banks’ transactions to place free liquidity are currently made at the key policy rate by buying overnight CDs, these MPC members said. An additional incentive to raise term deposits is also generated by differentiated reserve requirements.

All MPC members said they see room for further cuts to the key policy rate in 2024, although opinions differed on the pace of the interest rate easing

Seven discussion participants said they expect the key policy rate to decrease to 13% in 2024. The NBU should proceed with caution, taking into account planned FX liberalization measures, the projected acceleration of inflation in H2 2024, and a potential deterioration of economic agents’ expectations, these MPC members said. Risks associated with the energy sector and the financing of significant budgetary needs also persist. Under such conditions, the scope for lowering the key policy rate is limited.

By contrast, four MPC members said that such a level of the key policy rate would be too high, considering the current and expected inflation dynamics. Among other things, they said that in the coming months, the NBU will find evidence of sufficient resilience of inflation expectations and other favorable developments and will be able to speed up the lowering of the key policy rate to 11.5%–12% by the end of the year.

However, all discussion participants agreed that elevated uncertainty makes it difficult to forecast the level of the key policy rate even through the end of this year, let alone the years that follow. The NBU should stand ready to flexibly adapt its policy should considerable shifts occur in current macroeconomic developments and in the balance of risks to inflation and exchange rate dynamics. The NBU should focus more on the macrofinancial trends that are supported by data, and less on technical assumptions about security risk duration that are revised on a regular basis.