Date of the meeting: 17 July 2019
Attendees: nine out of 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
- Serhii Kholod - Deputy Governor
- Vitalii Vavryshchuk - Director of the Financial Stability Department
- Sergiy Nikolaychuk - 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 discussion, all of the MPC members advocated lowering the key policy rate in July. Eight members offered to cut the rate by 0.5 pp, to 17.0%, while one member suggested cutting it by 1 pp, to 16.5%.
Current macroeconomic conditions are favorable for continuing the cycle of monetary policy easing the NBU launched in April, the MPC members pointed out as they discussed these options.
In line with the baseline forecast scenario, if the NBU gradually lowers the key policy rate, its real value will remain high, considering the improvement in inflation expectations. Under these conditions, inflation should meet the 5% target in late 2020. Although domestic demand has been growing faster than expected, its impact on inflation has been balanced out by benign FX market conditions.
The main domestic risk to the baseline scenario – a further strengthening of threats to macrofinancial stability – remains relevant. The NBU has a limited capability to quantify this risk and to use monetary policy decisions to lower the likelihood that it will materialize, the MPC members said. This risk primarily arises from potential delays in implementing key reforms or from steps that invalidate past achievements. These steps include court rulings and legislative initiatives that may significantly increase the vulnerability of Ukraine’s economy and pose obstacles to continued cooperation with the IMF.
Despite a certain increase in volatility in May through early June, the situation in Ukraine’s financial market is favorable. Businesses and households are gradually getting used to the floating exchange rate and respond prudently when the range of its fluctuations widens.
This is having a positive effect on the behavior of inflation expectations. Households, businesses, banks, and financial analysts have improved their inflation expectations, recent surveys show. Inflation expectations of households and businesses have improved the most, reaching five-year lows.
However, with public confidence in the NBU’ ability to meet the inflation target only just beginning to take shape, the NBU must apply caution as it eases its monetary policy, most MPC members believe. In addition, the risk of inflation falling below the target is less significant now than the risk of it overshooting the target.
With that in mind, it would be premature to cut the key policy rate in July by more than 0.5 pp. Some of the MPC members, however, did not rule out the chance that going forward, the NBU might accelerate the monetary policy easing if signs of faster disinflation emerge.
By contrast, one MPC member argued that the key policy rate should be cut by 1 pp. The hryvnia has come under increased appreciation pressure from nonresidents’ heightened interest in Ukraine’s domestic government bonds, which the MPC member said was evidence that a 1 pp cut was necessary. This move, the MPC member argued, would also take into account the changes in the policies of leading central banks, in particular the anticipated easing of monetary policy by the Fed and ECB in response to slower economic growth. On top of that, it is easier to cut the key policy rate more actively when it is high than when it has reached lower levels.
The MPC members paid special attention to the first-ever publication of the NBU’s key policy rate forecast, expressing their unanimous approval of this publication. It will facilitate better understanding of the NBU’s monetary policy and macroeconomic outlook by all economic agents, the MPC members said. At the same time, it is important to have the key policy rate forecast accompanied by adequate communication support. The MPC members emphasized the need to make it clear that the NBU does not take responsibility to follow the projected trajectory of the key policy rate. The projected trajectory can vary as the NBU updates it macroeconomic outlook. The actual value of the key policy rate can deviate from the projected trajectory as the balance of risks changes and new information emerges. In communicating with the public, the NBU should mention the factors that may cause these deviations, one of the MPC members emphasized.
In the absence of significant economic shocks, the NBU may lower the key policy rate to a neutral 8% by the end of 2021, the MPC members agreed as they discussed the projected dynamics of the key policy rate.
The largest rate cut will take place in 2020 as inflation returns to the target range and inflation expectations improve, the MPC members projected.
However, the MPC members were somewhat divided over how quickly the NBU should cut the key policy rate. The projections of most MPC members matched the baseline scenario trajectory. At the same time, one MPC member said it would take longer than until 2021 to bring the key policy rate down to 8%. It will take a tighter monetary policy stance to anchor inflation expectations at 5%, the MPC member opined. Another MPC member said that, on the contrary, it should take the NBU less time to bring the key policy rate even below the neutral level. Foreign investors will pour capital into hryvnia-denominated assets, contributing to the NBU’s rate-cutting effort, the MPC member projected.
The MPC members pointed out there was difference of opinion among market participants regarding the expected key policy rate and the NBU’s projections. Their consensus forecast predicts a slightly higher key policy rate in 2019–2021. More specifically, it will take as long as until 2023 to bring the key policy rate to 8%, market participants believe. This is due to certain inertia in their projections and reliance to historical data: high inflation and, hence, high key policy rates in previous years. If the NBU successfully meets the 5% target, market participants should come closer to the NBU forecast.
The MPC members also discussed the risks associated with the inflow of capital in hryvnia-denominated government securities. These risks are currently insignificant, they believe. First, the inflow of capital only into the public sector does not pose risks that consumer demand may overheat, as fiscal policy remains balanced. Second, the gradual decrease in the cost of government borrowings and the extension of their maturity by the Ministry of Finance reduce the risks associated with debt refinancing. As of now, most of nonresidents’ portfolio of domestic government bonds is composed of securities with maturities of at least one year. In addition, maintaining the interest of foreign investors in hryvnia-denominated government bonds will continue to contribute to the gradual dedollarization, thus reducing FX risks. At the same time, there is a likelihood of an increase in nonresident demand for hryvnia-denominated domestic government bonds and thus a chance that the hryvnia will strengthen. This will create opportunities for larger key policy rate cuts compared to the baseline scenario.
The decision to set the key policy rate at 17.0% per annum was approved by the NBU Board at the monetary policy meeting held on 18 July 2019.
For reference:
The Monetary Policy Committee (MPC) is the NBU’s advisory body created for sharing information and opinions on monetary policy formation and implementation in order to deliver price stability. The MPC consists of 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 one day before the NBU Board meeting on monetary policy issues. Decisions on monetary policy issues are made by the NBU Board.