Date of the meeting: 22 April 2020.
Attendees: All ten members of the NBU Monetary Policy Committee (MPC):
- Yakiv Smolii - Governor of the National Bank of Ukraine
- Kateryna Rozhkova - First Deputy Governor
- Roman Borysenko - Deputy Governor
- Dmytro Sologub - Deputy Governor
- Sergii Kholod - Deputy Governor
- Oleg Churiy - Deputy Governor
- Vitalii Vavryshchuk – Director of the Financial Stability Department
- Volodymyr Lepushynskyi - Director of the Monetary Policy and Economic Analysis Department
- Yurii Polovniov - Director of the Statistics and Reporting Department
- Serhii Ponomarenko - Director of the Open Market Operations Department.
During the meeting, the MPC members directed considerable attention to the current and potential impact of the COVID-19 pandemic, as well as the restrictions imposed to withstand its spread, on the global commodity and financial markets. The quarantine measures have, as expected, limited business activity and negatively impacted production, employment, and household incomes. During the discussion, all MPC members agreed that the economy will need fiscal and monetary support to recover.
The current situation is substantially different from previous crises in the modern history of Ukraine, the MPC members noted. Thanks to the cleanup of the banking system, fiscal consolidation, a floating exchange rate, and a more effective monetary policy, the initial shock – in the form of a speculative weakening of the hryvnia and a surge in demand for certain goods during the first weeks of the quarantine – proved to be moderate and short-lived. Inflation remains lower than forecast. Price growth will accelerate moderately in the coming months as a result of the hryvnia’s depreciation in March, the MPC members expect. Inflation will nevertheless continue to be restrained by falling consumer demand and low energy prices. This, in the opinion of all MPC members, creates room to cut the key policy rate to support an economic recovery.
All members of the MPC spoke unanimously in favor of easing monetary policy in April 2020. However, given the high degree of uncertainty about the further impact of the pandemic on the global and Ukrainian economies, the MPC members differed on the size of the cut to the key policy rate.
Three MPC members suggested cutting the key policy rate by 100 bp, to 9%.
Inflation risks are moderate, as conditions in the FX market have quickly returned to normal following several weeks of speculative demand in March, these MPC members said. The impact the weaker hryvnia is having on inflation will fade in a few months. Prices for certain goods and services may rise after the quarantine, but this pressure on prices will be short-lived. Certain vegetables and fruits also are likely to increase in price due to adverse weather conditions.
At the same time, risks to macroeconomic stability remain high. In particular, this is evidenced by worsening inflation and exchange rate expectations among financial analysts, both for the current year and for the next two years.
In these circumstances, even a significant easing of monetary policy will only have a limited impact on the economic recovery. In contrast, the NBU in April should refrain from significantly reducing the key policy rate and, for greater effect, continue to soften monetary policy after the quarantine restrictions have been relaxed and an agreement with the IMF has been signed, these MPC members argued.
They also expressed concern that a decision by the NBU that was fundamentally different from market expectations could lead to a decline in confidence in the central bank’s monetary policy.
Two MPC members advocated a cut in the key policy rate by 150 bp, to 8.5%.
Consumer demand will remain low even after the lockdown has been lifted, they said. Households will reduce their spending as their incomes and savings fall, focusing primarily on meeting their essential needs. In addition, migrant worker remittances, which traditionally fuel domestic demand, will decline. Once the quarantine is over, cross-border traffic will remain restricted for some time.
Households will tend to accumulate “emergency funds” as fears of a new wave of the pandemic persist, and savings will take precedence over spending on nonessential needs. As a result, sustained weak consumer demand will hold back price increases. This is a reason to make a more significant cut to the key policy rate to support the economy while quarantine measures are still in effect.
However, an aggressive rate cut of more than 150 bp would pose certain risks. As uncertainty over how the situation will evolve remains high, low hryvnia interest rates will push economic agents to look for alternative assets, including those denominated in foreign currency. This will increase the dollarization of the economy and raise pressure on the hryvnia exchange rate, which could have long-term negative effects on financial stability.
Four MPC members argued that the key policy rate should be reduced by 200 bp, to 8%.
Speculative demand in the FX market, driven by psychological factors, and strong demand for essential goods have quickly subsided, they said. These factors will not have a significant impact on inflation, unlike the effect of curtailing domestic demand and the plunge in global energy prices.
Current projections underestimate the weakness of domestic demand, these MPC members believe. Influenced by this factor, inflation, which was consistently below 3% yoy during Q1 2020, will continue to grow fairly slowly, and is likely to end the year within the 5% ± 1 pp target range. Under these conditions, the current value of the key policy rate is too high, and reducing it by 2 pp would thus be an appropriate step, signaling to the market that the NBU stood ready to support economic growth by monetary means.
Most analysts predict a further easing of monetary policy, but expect inflation – and thus the key policy rate – to be higher, one MPC member said. The NBU, however, is sufficiently confident in its inflation forecast, which is lower than the market expects, and should therefore act in line with its own forecasts. A decisive but justified cut to the key policy rate would in this case be perceived by market participants as appropriate, and would not compromise confidence in the NBU’s monetary policy.
Central banks in many countries have shifted to quantitative easing as their key policy rates have approached zero. As a monetary policy tool, key policy rates have only a limited impact in these conditions. In contrast, the key policy rate in Ukraine remains high, enabling the NBU to make aggressive rate cuts to provide stimulus to the economy as it emerges from quarantine and makes its way towards a full recovery of economic activity.
In support of this decision, participants of the MPC meeting also pointed to positive signals about continued cooperation with the IMF and financial support from other international partners, in particular the EU and the World Bank.
One MPC member argued that the key policy rate should be reduced by 250 bp, to 7.5%.
The NBU should base its key policy rate decisions on the future course of inflation, the MPC member stressed. The forecasts assume that despite accelerating modestly in the coming months, inflation will remain in the 5% ± 1 pp target range, ending 2020 at 6%. However, weaker-than-projected consumer demand could slow inflation as it returns to its target range. With low inflation in Ukraine and significant deflationary risks in the global economy, the central bank has wiggle room to lower the key policy rate even further.
Given the fairly rigid, pro-inflation risk-oriented monetary policy that the NBU conducted in previous years, market participants are expecting a smaller key policy rate cut, this MPC member said. However, macroeconomic conditions are now different from those in the years leading up to the pandemic. With inflationary pressures at low levels and the economy in need of support, the NBU should act more decisively.
In revising the forecast trajectory of the key policy rate, the MPC members were also not unanimous, as their opinions were directly dependent on their expectations and arguments for lowering the key policy rate in April.
As before, two MPC members expect that by the end of 2020 the key policy rate will have been cut to 7%.
The forecast should take into account significant uncertainty over how events are will unfold in Ukraine and the world, and the key policy rate should not be lowered beyond the 8% level, three MPC members suggested.
The sharper reduction in inflationary pressure than the one forecast gives the NBU room to make a deeper key policy rate cut, five MPC members said. One of these MPC members expects the key policy rate to be cut to 6.5% in 2020, while the rest forecast that it will be reduced to 6%.
Within the context of reducing the key policy rate to a single-digit level, the MPC members also discussed the question of narrowing the NBU’s rate corridor for standing facilities (overnight loans and certificates of deposit), which now equals the key policy rate ± 2 pp. In determining the width of this corridor, central banks that target inflation choose between amplifying the monetary transmission mechanism and supporting the operation of the interbank market. By narrowing the rate corridor for standing facilities, the NBU will be better able to pursue its operational goal – maintaining interbank rates at levels close to the key policy rate. However, this may have a negative impact on the volume of transactions between banks, which would choose the NBU over other counterparties. Narrowing the corridor would also weaken the effect of easing monetary policy, as interbank rates tend to fall to the lower bound of the rate corridor.
In light of these arguments, the MPC members agreed not to change the present width of the rate corridor for standing facilities, but to return to this matter at subsequent meetings.
A decision to set the key policy rate at 8.0% per annum was approved by the NBU Board at the monetary policy meeting held on 23 April 2020.
For reference:
The Monetary Policy Committee (MPC) is an NBU advisory body that was created to share information and opinions on monetary policy formulation and implementation, in order to deliver price stability. The MPC comprises the NBU Governor, other NBU Board members, and directors of the Monetary Policy and Economic Analysis, Open Market Operations, Financial Stability, and Statistics and Reporting Departments. The MPC meets the day before the NBU Board meeting on monetary policy issues. Decisions on monetary policy issues are made by the NBU Board.