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On Money Market Regulation

Having analyzed the dynamics of macroeconomic and monetary indicators, the NBU Board has noted an acceleration of inflation in Ukraine. In annual terms, the CPI in October 2014 increased to 19.8%, up from 0.5% in January 2014.

The acceleration was both due to an increase in administered prices (25.8% yoy) as unpopular but necessary reforms took place and because of the hryvnia’s depreciation against the U.S. dollar by 58.9% in January–October 2014.

The latter was driven by a mismatch in Ukraine’s FX market that arose from external imbalances accumulated in previous years and by the deterioration of expectations as sociopolitical and military events unfolded in Ukraine.

The real economy continued to operate in dire conditions, which also adversely affected the value of the hryvnia. Despite the substantial reformist efforts of the Ukrainian government and the NBU, major macroeconomic indicators are trending down. Specifically, the decrease in real GDP in Q3 was 5.1% compared to 4.6% and 1.1% in Q2 and Q1 2014, respectively.

The deterioration in aggregate production dynamics is due to the events in the east of Ukraine, which have rendered a significant number of companies unable to do business. At the same time, mutual restrictions in foreign trade with russia are reducing external demand for Ukrainian-made products. 

The lack of de-escalation of russia’s military aggression against Ukraine has made negative expectations worse. This has led to the acceleration of deposit outflows from the banks and the increase in demand for foreign currency in recent months after business conditions in June 2014 appeared to have stabilized. 

In particular, having slightly grown in July–October 2014, hryvnia retail deposits shrank again (by UAH 16.8 billion). 

The net demand for FX cash, which was USD 1.0 billion in July–October 2014, also resumed its dominance. 

In addition, since August 2014, net FX supply has been replaced by net demand in the interbank market. In August–October 2014, the market had a net FX demand of USD 4.6 billion.

In addition, the worsening of market expectations and the subsequent depreciation of the hryvnia are driving additional inflationary pressure. It will remain elevated at the beginning of next year, the NBU forecasts. 

Under such conditions, the NBU has taken a set of measures to balance the Ukrainian FX market through market-based tools (interventions to sell foreign currency) and administrative controls.

At the same time, with Ukraine’s businesses and money market operating under extraordinary conditions, the stabilizing measures taken by the NBU need to be amplified by applying interest rate policy tools to strengthen the hryvnia. 

Efforts to accomplish this through market-based mechanisms will contribute to the stabilization of all segments of the money market and testify to the NBU’s determination to fulfill its mandate of achieving and maintaining price stability in the medium term. 

This analysis also takes into account that an increase in the key policy rate at this point will have a negligible impact on the real economy’s development, as the banks’ lending activity remains low-key due to increased risks of doing business. 

With this in mind and in accordance with Articles 6 and 25 of the Law of Ukraine On the National Bank of Ukraine and the Regulation On Interest Rate Policy of the National Bank of Ukraine approved by NBU Board Resolution No. 389 dated 18 August 2004 (as amended), the NBU Board has passed Resolution No. 719 On Money Market Regulation dated 12 November 2014, which stipulates, among other things, that the key policy rate is to be set at 14.0% from 13 November 2014.

For reference:

In line with paragraph 1 of NBU Board Resolution No. 417 On Money Market Regulation dated 15 July 2014, the key policy rate has stood at the level of 12.5% per annum since 17 July 2014.


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