Summary of Key Policy Rate Discussion by NBU Monetary Policy Committee on 30 October 2024

Meeting date: 30 October 2024

Attendees: 10 out of 11 members of the Monetary Policy Committee (MPC) of the National Bank of Ukraine:

• Andriy Pyshnyy, Governor of the National Bank of Ukraine 
• 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 reasons for the increase in price pressures and assessed the likely persistence of this uptrend and its impact on economic agents’ expectations. The meeting also placed considerable focus on discussing the optimal combination of monetary policy instruments to slow down inflation next year and return it to the 5% target.

Consumer inflation has been rising in recent months, the MPC members said. On the one hand, this uptrend was reflected in the NBU’s previous forecasts (Inflation Reports of January, April, and July 2024). As expected, the pickup in inflation was driven by the impact of lower harvests this year and a related increase in raw-material prices, the further growth in production costs, specifically of power and wages, as well as exchange rate effects. On the other hand, the impact of most of these factors on price developments turned out to be more significant than projected. Consumer inflation (8.6% yoy in September) significantly surpassed the NBU’s forecast, while underlying price pressures, as measured by core inflation (7.3% yoy in September), deviated from the forecast even more noticeably.

To counteract price pressures, the NBU in July suspended its interest rate policy easing cycle and made efforts to preserve the sustainability of the FX market. These actions and related forward guidance by the NBU halted the decline in nominal interest rates on hryvnia term deposits. The yield on hryvnia instruments continued to exceed economic agents’ inflation expectations, which – though marginally worse than before – generally remained quite sustainable. As a result, hryvnia retail deposits with maturities of at least three months returned to growth, and investments in hryvnia domestic government debt securities continued to rise.

Efforts to sustain investor appetite for hryvnia instruments is restraining potential pressures on international reserves. In addition, uncertainty over the sufficiency of foreign aid has eased off. In particular, Ukraine’s partners have come significantly closer to handing profits from frozen russian assets over to Ukraine through ERA Loans. This will make it possible to maintain the appropriate level of international reserves, preserving the sustainability of the FX market and thus reinforcing the NBU’s capability to ensure that inflationary processes are controlled.

Thanks to the NBU’s combination of interest-rate and exchange rate policy measures and other instruments, and considering the expected increase in the supply of food products and a weakening of external price pressures, it is projected that the inflationary surge will be relatively short-lived. Under the forecast’s baseline scenario, consumer inflation will be in the double digits only during H1 2025, getting back on track to a sustainable slowdown as soon as spring.

However, the war grinds on and uncertainty remains high, and the balance of risks to inflation has shifted upwards. If pro-inflationary risks, primarily those fueled by the war’s impact, materialize, price pressures may come out more persistent than currently expected. With this in mind, the NBU should continue to take a balanced and consistent approach to monetary policy.

Nine MPC members called for keeping the key policy rate at 13% in October.

In combination with maintaining a sustainable FX market, the current level of the key policy rate is sufficient to retain control over inflation expectations, restrain inflation, and return it to the 5% target in the coming years, these discussion participants said. The revitalization of public interest in hryvnia term deposits and domestic government debt securities this fall, amid the preserved sustainability of inflation expectations, indicates that the NBU has been successful in pursuing the goal of protecting hryvnia savings from losing value to inflation. In addition, such a step will be completely consistent and predictable in view of the regulator’s previous communications, while it is important that the NBU continue to reduce economic uncertainty. Specifically, according to the vast majority of surveyed professionals, keeping the key policy rate unchanged in October is the most anticipated and viable step.  

The positive news about Ukraine’s receipt of significant amounts of international funding should also help keep expectations under control, one of the discussion participants said. Based on the expected volume of disbursements by the end of the year, international reserves should surpass USD 43 billion, and further financing under the ERA Loans program could largely dispel concerns over possible scarcity of financial support next year. In practice, this will also substantially shore up the NBU’s capacity to ensure sustainable conditions in the FX market.

The forecast’s baseline scenario has inflation peaking in spring 2025. So, given the monetary transmission lag, it is currently not feasible for the NBU to respond to the inflationary surge by taking interest rate policy measures, two MPC members said.  The current inflation surge is partly driven by this year’s less ample harvests and other factors that will eventually wear off. 

However, the NBU cannot fully rely only on the effects from the exhaustion of the impact from temporary factors, as the spike in prices may acquire fundamental attributes and become more persistent than currently projected, another MPC member said. In particular, no matter the nature of the initial inflationary surge’s drivers, high inflation usually triggers a speedup of inflationary processes, especially in times of significant uncertainty. The lack of the central bank’s response under such circumstances can lead to a long-term anchoring of inflation at high levels. Many countries have learned this lesson the hard way. The NBU should therefore be ready to act decisively if a further acceleration of inflation threatens to unanchor inflation expectations.

This opinion was supported by another participant in the discussion, who said that this year’s harvests are not the only reason for the current uptick in inflation. Fundamentals, including those related to the difficult situation in the labor market and other consequences of the war, are also having a significant impact on price developments. The pass-through of exchange rate depreciation effects to prices is probably also intensifying. What is more, the already heightened level of geopolitical uncertainty is further increasing as certain countries go through electoral cycles. In other words, there are many factors that can result in a reversal of monetary policy. Macrofinancial stability cannot be taken for granted. To ensure it, the NBU must be ready to take decisive action. 

One MPC member spoke in favor of raising the key policy rate to 13.5% in October.

This MPC member said he had actually advocated for a key policy rate hike at the MPC’s previous meeting already. There is now even more evidence that such a step would be viable, this participant said. Price pressures continue to outpace the forecast, and inflation expectations are deteriorating, if only marginally so far. The balance of risks to inflation remains shifted upwards. Specifically, there is a high probability of the budget deficit expanding further. Its financing remains a significant challenge even amid upbeat news that external financial support will keep coming.

In addition, the updated macro forecast’s baseline scenario has inflation staying above the target for long, sometimes even venturing into double-digit territory. This should be perceived as a significant risk of unanchoring of inflation expectations, potentially causing a substantial decline in the real yield on hryvnia instruments. A cooling of appetite for hryvnia instruments would spark an additional jump in FX demand, which has already been rather strong in recent months. These are conditions under which a hike of the key policy rate would prove the NBU’s willingness to continue to ensure price stability and proper protection of hryvnia savings against inflation, not only in the moment, but also going forward.

The MPC members also discussed the feasibility of further steps to modify the operational design of monetary policy.

One of the participants in the discussion once again proposed to consider suspending transactions with three-month certificates of deposit (CDs). Such an action will not have a significant impact on the banks’ interest rate policy, because the volume of such CDs in their portfolios is shrinking fast, this participant said. The main liquidity-absorption transactions are taking place at the rate on overnight CDs, which now equals the key policy rate. The latter’s impact on market processes is therefore decisive, and differentiated provisioning ratios are effectively performing the role of an auxiliary tool to keep real rates on hryvnia deposits sufficiently high.

The activation of lending, including to consumers, and of transactions with domestic government debt securities is fueling the banks’ competition for term deposits, this MPC member said. Suspending three-month-CD transactions will therefore affect only the deposit rates of relatively few banks and will have little impact on monetary conditions, this MPC member said. At the same time, there will be room to reduce the spread between the key policy rate and the rate on refinancing loans to 1 pp, strengthening the banks’ liquidity management flexibility and helping further activate the domestic debt market.

By contrast, the rest of the MPC members said that changing the operational design of interest rate policy in such a way would be unviable. The impact of the key policy rate on market processes has increased over the past 12 months, but this alone is not enough to rely on, they said. The use of additional monetary instruments, including three-month CDs, will continue to play an important role in the shaping of appropriate monetary conditions. In particular, the task of maintaining sufficiently high interest rates on term hryvnia instruments to protect savings from inflation remains relevant, which will continue to help restrain pressure on the FX market and maintain international reserves.

According to calculations, one discussion participant said, the banks’ previous reactions to the adjustment of the operational design showed a rather strong correlation between the rates on three-month CDs and the rates on hryvnia term deposits. Most banks are still using up all of their available cap on three-month CDs. This instrument will therefore continue to play an important role in ensuring the optimal yield on hryvnia instruments. In contrast, suspending transactions with three-month CDs without putting in place any compensators will significantly loosen interest rate policy and dampen depositor appetite for hryvnia savings amid a further ratcheting up of price pressures, something that is inconsistent with the NBU’s tasks. 

The vast majority of the MPC members expect the key policy rate to remain at 13% in the months ahead, without ruling out the chance of a hike.

None of the discussion participants mentioned any grounds to ease interest rate policy in the coming months. Given where inflation expectations are now, and provided that the FX market continues to be sustainable, keeping the key policy rate at 13% will be enough to ensure that hryvnia savings are adequately protected from being eroded by inflation, eight MPC members said.

Two MPC members said, however, that as price pressures go up and some of the pro-inflationary risks materialize, economic agents’ expectations may deteriorate significantly, an outcome that will adversely affect the real yield on hryvnia instruments and require the NBU to respond accordingly. In December, they said, the rate will have to be raised to 14%.

The MPC members agreed that with price pressures having risen above the forecast and with the balance of pro-inflationary risks having shifted higher, the forward guidance articulated in the press release on the key policy rate should point one way only – upward. Specifically, it would be feasible to verbalize the NBU’s readiness to respond to the materialization of inflation risks and the threat of expectations being unanchored. This would reiterate the NBU’s intention to bring inflation to its 5% target within the policy horizon and make life less uncertain for economic agents.

Meanwhile, the MPC members agreed that next year, probably after inflation peaks, the NBU will have some wiggle room to cautiously loosen interest rate policy. The vast majority of MPC members anticipate that the key policy rate will end the year 2025 at about 12%. However, this rate forecast is highly likely to undergo revisions because of extreme uncertainty pertaining to wartime conditions and the scale of challenges facing the Ukrainian economy, they said. The NBU should continue to act flexibly and base its key policy rate decisions on changes in the balance of risks to inflation and economic development.