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National Bank of Ukraine modifies the monetary policy framework while tightening the monetary policy stance

As part of the run-up to the adoption of the inflation-targeting regime, the Board of the National of Ukraine has adopted a decision to modify the operational framework for monetary policy implementation and enhance monetary policy efficiency and transparency for market participants.

The decisions were taken in line with recommendations provided by the Monetary Policy Committee (hereinafter – the Committee) based on the analysis of the outlook for the economy and the money market.

The main changes include:

making the discount rate more instrumental as the benchmark monetary policy rate. Interest rates on liquidity adjustment instruments will be set in line with the discount rate;

scrapping the practice of holding foreign exchange auctions (effective from February 5, 2015) and setting the indicative hryvnia exchange rate. The hryvnia exchange rate will be set by banks based on the objective parameters of market demand and supply.

This will help eliminate uncertainty, enhance the effectiveness of the price-setting mechanism for lending resources and foreign exchange available in the interbank market, and make the monetary instruments used by the National bank more effective.

At the same time, with a view to ensuring that the market will follow a projected path and the market situation will be kept under control, the National Bank of Ukraine will tighten the monetary policy stance. To this end, the regulator has adopted a decision (effective from February 6, 2015) to raise the discount rate from 14.0% to 19.5% per annum and adjust interest rates on NBU's liquidity-providing and liquidity-absorbing operations.

The main reason behind this decision was stronger inflation risks, which are likely to remain heightened in the near term, reflecting primarily considerable uncertainty over the developments in the east of Ukraine. In December 2014, annual CPI inflation reached 24.9%. The core inflation rate picked up to 22.8%, having accelerated drastically in the past three months. The main factor behind the higher inflation rate was the depreciation of the hryvnia exchange rate as a result of imbalances built up over the past years and worsened expectations amid the social and political turmoil and the military conflict in the east of Ukraine. A rise in administered prices linked to the implementation of much-needed economic reforms was the main contributor to an increase in consumer inflation.

A more rigid monetary policy pursued by the National Bank of Ukraine will help stabilize the money market thanks to the greater attractiveness of financial instruments denominated in hryvnia and points to the NBU's resolve to meet its priority goal of achieving and maintaining price stability in Ukraine. The decision to raise interest rates, along with other contingency measures taken by the Government and the National Bank of Ukraine as part of a new program supported by the IMF would help contain inflation rates as early as in the first half of 2015 and pave the way for bringing inflation down to one digit levels in 2016. According to the NBU's forecasts, CPI inflation will stand at 17.2% at the end of 2015.

At the same time, higher interest rates will have little impact on business activity in the real economic sector, as bank lending activity remains considerably subdued amid heightened risks in the business environment. A GDP fall estimated by NBU experts at 6.7% in 2014 was of structural nature and was driven by supply-side factors. A negative GDP gap stood at – 8 – 9%, with actual GDP falling below its potential level. According to estimates made by NBU experts, actual GDP could reach potential GDP in the mid-term perspective only if macro-financial stabilization is achieved, with a more rigid monetary policy playing a key role in it.

The analysis of the impact of potential risks arising from higher interest rates on the banking system stability has suggested that these potential risks are relatively low compared to the risks of further depreciation of the hryvnia. In addition, higher interest rates across the banking sector have to encourage the return of household deposits to the banking system and reduce inflation pressure. The macro-financial stabilization in the country will also contribute to it.

Along with the decision to raise the discount rate, the National Bank of Ukraine intends to strengthen its role as the benchmark monetary policy rate. In particular, interest rates on liquidity adjustment instruments will be set closely in line with the discount rate. This move will ensure the alignment of all the interest rates used by the National Bank. The operational framework of the monetary policy with the discount rate at its core will become simpler and more transparent for market players.

For reference

The discount rate is the base rate for the National Bank of Ukraine's other rates. The discount rate serves as a benchmark for measuring the value of borrowed funds. By changing the discount rate, the National Bank of Ukraine sends a signal to market participants about the stance of the monetary policy and signals that it is resolute in its efforts to exercise its main function in ensuring the hryvnia stability.

The discount rate was last changed on November 12, 2014, when it was set at 14% per annum.

The Committee was set up by the National Bank as part of the NBU transformation project in order to strengthen the institutional capacity, streamline the monetary policy decision-making process and enhance public communications about the rationales for these decisions. The Committee is focused on drafting proposals on setting and changing the discount and other interest rates of the NBU; parameters of operations with assets and liabilities for the purpose of banking system liquidity regulation; formulating and implementing the exchange rate policy; determining the amount and procedure of formation of the banks’ obligatory reserves; monetary and fiscal policies coordination.

The Committee's next meeting has been scheduled for February 25, 2015.

Detailed information about the Committee can be found at:

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