Summary of Key Policy Rate Discussion by NBU Monetary Policy Committee

Date of the meeting: 9 December 2020.
Attendees: nine out of ten members of the Monetary Policy Committee (MPC) of the National Bank of Ukraine:

• Kyrylo Shevchenko, Governor of the National Bank of Ukraine
• Kateryna Rozhkova, First Deputy Governor
• Yurii Heletii, Deputy Governor
• Dmytro Sologub, 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
• Yurii Polovniov, Director of the Statistics and Reporting Department. 

During the meeting, the MPC members paid special attention to the economic fallout from the pandemic, and discussed the dynamics of consumer prices in recent months and the likely inflation developments in 2021.

The participants noted a further increase in the level of uncertainty surrounding the spread of COVID-19 and its impact on economic processes. On the one hand, the economies of Ukraine and other countries in Q3 recovered even faster than economists expected. Growing indicators of retail trade and imports were evidence that consumer demand continued to recover. Active spending by households amid rising incomes, higher energy prices, a poorer harvest, and the pass-through of a weaker hryvnia into prices led to faster inflation. A low comparison base also made a significant contribution. As a result, inflation accelerated rather sharply in November, to 3.8% yoy.

Current developments appear to be following the baseline macroeconomic scenario projected by the NBU (see the October 2020 Inflation Report). Under this scenario, economic growth will continue in the coming years, with inflation temporarily breaching the upper bound of the 5 +/- 1 pp target range in 2021 and returning to the target in 2022.

At the same time, the further spread of COVID-19 poses risks to business activity and may ease inflationary pressures. The higher prevalence of disease and the imposition of new quarantine restrictions are significantly constraining business investment and suppressing consumer sentiment. This has been highlighted, in particular, by the Business Activity Outlook Index, which fell in November. Companies in all sectors the economy said they were pessimistic about their performance in the near future. In addition, the Consumer Sentiment Index in October fell to its lowest since January 2019. Among other things, respondents said they were much less willing to make large purchases in the short run. Meantime, inflationary pressures may ease as neighboring countries tighten their quarantine measures.

Uncertainty about fiscal stimulus in 2020–2021 remains high, the MPC members pointed out. This applies to both December injections and next year’s budget expenditures. Being traditionally high, the former can lead to higher inflationary and depreciation pressures.  The state budget for 2021, approved by the Parliament, assumes that fiscal policy will continue to be rather loose, fueling both economic activity and price growth. However, the actual fiscal impulse will depend on the implementation of the fairly ambitious revenue plan and the availability of funding sources to finance the budget. As with this year, Ukraine will have to meet its international commitments next year to be able to close the budget gap.

The MPC members unanimously offered to leave the key policy rate unchanged at 6%

This solution is optimal in the current conditions, the participants of the discussion pointed out. Most of them did not weigh other options. Given elevated uncertainty, a significant acceleration of inflation, and deteriorating expectations, cutting the key policy rate further could send the wrong signal to market participants and fail to have a positive impact on market rate dynamics.

The yield on domestic government debt securities in the primary market increased due to significant financing needs of the government, the MPC members said. This exerted certain pressure on banks’ interest rates. In particular, rates on certain types of deposits stopped declining, while the return on some of them actually increased. This reversal also reflected the worsening expectations of businesses and households. Thus, an easing of monetary policy would contradict expectations and make them deteriorate further. 

December is not the best time to revise the key policy rate due to heightened uncertainty regarding budget deficit financing, the MPC members said. The increase in budget expenditures at the end of the year may put more pressure on the FX market. However, the MPC members also discussed an assumption that with interest rates across the world continuing to be low, foreign demand for Ukrainian hryvnia government bonds may increase in 2021. This may strengthen the hryvnia and decrease the yields on domestic government debt securities, bringing them closer to the key policy rate.

The baseline macroeconomic scenario looks rather realistic, so it is advisable to follow the key policy rate forecast published in the October 2020 Inflation Report, three MPC members said. The NBU projected that inflation would accelerate at the end of the year and also expected a certain tightening of quarantine restrictions and the realization of fiscal risks in terms of financing the state budget deficit, one of the three MPC members emphasized.

Inflationary pressures from outside the country could also increase, another MPC member suggested. Further recovery in the global economy will be accompanied by rising prices for fuel, grain, metals, and other commodities. This factor will play an important role in inflation developments in H2 2021, when vaccination is likely to have a significant effect on reducing the prevalence of disease in the world, this MPC member said. In addition, the increase in production costs, including due to higher wages, may be reflected in consumer prices at the beginning of the year.

Another MPC member pointed out that wages and retail trade were growing rather rapidly, generating inflationary pressures. At the same time, he doubted that such a strong trend would continue, as businesses would be reluctant to raise salaries during the crisis amid excess labor and weak demand for certain goods and services. 

Several participants discussed the choice between maintaining and lowering the key policy rate. The NBU has reason to be proactive and ease its monetary policy in view of the expected tightening of the quarantine and the respective cooling of business activity and consumer demand, these MPC members said. However, the key arguments in favor of keeping the key policy rate unchanged were the acceleration of inflation in November and the softer-than-expected quarantine restrictions the government said it would impose in January. These restrictions may have relatively marginal effects on economic activity.

The MPC members were divided over the projected trajectory of the key policy rate

The key policy rate could be raised in 2021, most MPC members admitted. As the economy recovers, inflationary dynamics will generally be in line with the basic macroeconomic scenario, they suggested. With that in mind, the NBU will have to tighten its monetary policy in 2021 to curb inflationary pressures. The projections of these MPC members regarding the key policy rate at the end of 2021 ranged from 6.5% to 7.5%, but were overall closer to the upper limit.

Meanwhile, several participants in the discussion said that the economy’s path to sustainable growth might be more difficult. The pandemic will hold back a steady recovery in business activity until large-scale vaccination begins. Under these conditions, inflationary pressures will ease, enabling the NBU to give the economy more support through a lower key policy rate. However, there is little room for further rate cuts – no more than 0.5 pp to 1 pp – these MPC members warned.

In general, the NBU should be ready to loosen its monetary policy at future meetings if the spread of COVID-19 follows a negative scenario, all participants in the discussion agreed. The trajectory of the key policy rate will also strongly depend on the real size of fiscal stimulus in 2021, they said.

The decision to keep the key policy rate at 6.0% per annum was approved by the NBU Board at the monetary policy meeting held on 10 December 2020.