Summary of Key Policy Rate Discussion by NBU Monetary Policy Committee on 8 September 2021

Date of the meeting: 8 September 2021.
Attendees: all ten members of the Monetary Policy Committee (MPC) of the National Bank of Ukraine:

• Kyrylo Shevchenko, NBU Governor
• Kateryna Rozhkova, First Deputy Governor
• Yuriy Heletiy, Deputy Governor
• Yaroslav Matuzka, Deputy Governor
• Sergiy Nikolaychuk, Deputy Governor
• Oleksii Shaban, Deputy Governor
• Vitalii Vavryshchuk, Director of the Financial Stability Department
• Volodymyr Lepushynskyi, Director of the Monetary Policy and Economic Analysis Department
• Oleksii Lupin, Director of the Open Market Operations Department
• Yuriy Polovniov, Director of the Statistics and Reporting Department. 

During the meeting, the MPC members paid special attention to the temporary and underlying inflationary pressures, the dynamics of inflation expectations, and the balance of risks for further inflation developments and economic growth.

Inflation developments are generally in line with the baseline scenario of the NBU’s latest macro forecast (July 2021 Inflation Report), the discussants noted. Driven by both temporary and underlying inflationary pressures, headline inflation is currently in the double digits, as expected.

One of the main drivers of such inflation dynamics is the sustained high price level in the global commodity markets. Inflation in Ukraine’s MTPs also remains high, although in August there were signs of a slowdown. The rise in consumer prices is fueled, among other things, by increases in businesses’ production costs, including both raw materials prices and wages. The high growth in wages primarily reflects the overall revival of economic activity and some administrative decisions (a minimum wage increase, a revision of wages in healthcare and education, and wage supplements for physicians). Upward pressure on wages is probably also due to the recovery of migration activity and the shortage of skilled workers in the labor market.

Domestic consumer demand also remains robust. This is according to data from various sources: high retail trade growth, record car sales, accelerating consumer goods imports, growing foreign tourism, higher-than-expected price increases for services, and more. The Consumer Sentiment Index, in particular the propensity of respondents to make large purchases, is high. These trends may be related to the worsening of household inflation expectations. Financial analysts have also increased their projections for inflation.

However, signs of stabilization in underlying inflationary pressures are starting to emerge.   Year-on-year core inflation has stayed slightly above 7% in recent months. This has been driven, in particular, by the strengthening of the hryvnia.

The economy continues to recover fast, the MPC members also pointed out. GDP growth in Q2 2021 (5.4% yoy) was weaker than the NBU projected (7.5% yoy), early GDP data from the SSSU show, but this gap is largely due to temporary and technical factors. These factors include harvesting delays due to weather conditions, a negative contribution from wholesale trade amid disruptions in the supply of petroleum products, some technical aspects of this metric’s calculation, and more restrained budget expenditures at the end of the quarter.

The economic recovery has continued into Q3, high-frequency data show. It is driven by high crop yields (which may surpass the NBU’s July forecast based on July–August data), favorable external conditions, sustained consumer demand, and a pickup in investment against the backdrop of improved business performance. Business expectations have also improved further.

Given these developments, the MPC members unanimously supported a key policy rate increase to 8.5%.

In their opinion, inflation should follow the previously announced projected trajectory of the key policy rate, as the macroeconomic situation is developing quite closely to the baseline scenario of the NBU’s latest macro forecast. Factors that could change the key policy rate trajectory are currently balancing each other out. Specifically, a stronger hryvnia is offsetting external pressures on consumer prices.

At this time, it is important to avoid mismatches in inflation expectations, the MPC members also agreed. With prices for consumer goods and services rising, household expectations can deteriorate rapidly, creating additional price pressures. To prevent this from happening, the monetary policy must remain consistent and balanced. Raising the key policy rate to 8.5% in September is the most anticipated step, according to various expert surveys. This decision will thus have a positive impact on inflation.

Analysts’ expectations regarding the dynamics of the key policy rate in 2021 are anchored to the NBU’s projected trajectory, but in 2022 analysts expect the rate to come out higher than the central bank projected, one MPC member pointed out.

The discussants emphasized the need to strengthen the interest rate channel of monetary transmission. To better influence the dynamics of market interest rates, the NBU should not only raise the key policy rate, but also continue to normalize the operational design of its monetary policy, in particular by reducing the maturity of refinancing loans it offers through weekly tenders, the MPC members said. In addition, they emphasized the need to completely phase out the long-term refinancing and interest rate swaps with banks that the NBU has been using as emergency monetary measures.

In discussing the projected trajectory of the key policy rate, most MPC members said they expected the key policy rate to remain at 8.5% until the end of the year.

Raising the key policy rate to 8.5% in 2021 and rolling back the emergency monetary measures will be sufficient to ease inflationary pressures and return inflation to 5% in 2022, most discussants agreed.

Meanwhile, one discussant said that due to the significant predominance of proinflationary risks, in particular the combination of growing external price pressures and strong domestic demand, the NBU will have to raise the key policy rate in 2021 by another 0.5 pp, to 9%.

The NBU should be ready for a scenario in which it may have to tighten its monetary policy over the forecast horizon as needed, several of these MPC members emphasized as they assessed the risks. Should external price pressures intensify and inflation expectations worsen, it may be necessary to either increase the key policy rate further or keep it at the current level (8.5%) longer than is projected in the NBU’s July macroeconomic forecast, these MPC members noted. According to this forecast, the regulator expects to start a cycle of key policy rate cuts in Q2 2022.

The decision to set the key policy rate at 8.5% per annum was approved by the NBU Board at the monetary policy meeting held on 9 September 2021.