Dear colleagues,
Please be informed that the Board of the National Bank of Ukraine has decided to keep its key policy rate at 25% per annum. Under current conditions, such level of the key policy rate is sufficient to maintain exchange rate stability and keep inflation processes under control. At the same time, it is important to enhance monetary transmission and further improve the attractiveness of hryvnia assets, on which the NBU is currently working.
What price dynamics followed the previous NBU Board meeting on monetary policy issues?
As expected, inflation continued to accelerate in July and August. According to the NBU’s preliminary estimates, it reached around 23% last month. However, the overall price growth was more moderate compared to the NBU’s forecast. This was primarily due to a faster-than-expected decline in fuel prices and slower growth in prices for some vegetables.
At the same time, inflationary pressures remain strong, mostly due to the effects of the war, including the destruction of production facilities and disruption of logistics. A deterioration in inflation expectations is adding to the price pressure. Inflation was also influenced by the correction of the official exchange rate of the hryvnia in July, which was, however, necessary to maintain the resilience of the economy and the financial system over a longer term.
How will prices change further on?
Inflation processes will remain under control, in particular thanks to measures taken by the NBU and the government.
A one-time correction of the hryvnia official exchange rate and additional measures taken by the NBU to ease the pressure on the FX market helped reduce FX market imbalances. The NBU’s net FX sales were much lower in July and August than in the previous months. Coupled with large amounts of international financial assistance, it drove FX reserves up to USD 25.4 billion in August.
Ukraine’s international reserves are sufficient to keep the exchange rate fixed at the current level, taking into account the prospects of receiving the official financing from international partners, a gradual setting up of logistics, and a respective increase in export earnings.
In the medium run, a gradual normalization of fiscal policy will also help keep inflation processes under control. In particular, re-imposing import taxes in July increased the government’s ability to finance wartime expenses from revenues, thus reducing the need for monetary financing: monthly volumes of budget monetization decreased to UAH 30 billion in July and August, down from UAH 105 billion in June.
Further growth in yields on hryvnia deposits and domestic government debt securities will also put the brakes on inflation processes. The launch of the secondary market of domestic government debt securities gave a strong impetus to the growth in yields on these securities. Increased attractiveness of hryvnia savings will allow reducing demand for foreign currency and durable goods.
Fixing utility tariffs will also be an important factor in restraining inflation.
What were the other considerations behind today’s decision?
Progress in cooperation with international partners, including the International Monetary Fund, is an important precondition for the stable functioning of the economy in wartime.
By the end of the current year, Ukraine expects to receive declared official financing totaling about USD 12 billion, including EUR 8 billion as macro-financial aid from the EU.
Ongoing international support will enable the NBU to maintain international reserves at a sufficient level in the coming years.
Extended full-scale war against Ukraine by russia remains the key risk for Ukraine’s economic development
The speed at which the Ukrainian economy recovers and inflation returns to a slowing trajectory largely depend on when the active phase of the war ends.
Other inflationary risks have decreased in the short term since the NBU Board made its previous key policy rate decision. However, they remain significant in the long-term. Among other things:
First, the Black Sea ports opened earlier for grain exports than the NBU had envisaged earlier. This increases inflows of export earnings. However, the stability of sea exports remains vulnerable, particularly in the light of the latest statements made by the authorities of the aggressor country.
Second, the lack of progress in reimposing excise duties on fuel and introducing additional taxes on imports is putting less pressure on prices in the short term. At the same time, insufficient measures to limit imports and balance public finances pose risks to both fiscal stability and the central bank’s ability to maintain control over inflation, as well as to macro-financial stability in general.
Third, the implementation of new financial support initiatives by the United States will increase Ukraine’s international reserves in 2022 beyond the forecast. This will positively affect economic stability and expectations. Instead, the prospects for the non-monetary financing of the budget deficit in 2023 remain largely uncertain.
Fourth, the still low interest rates on domestic government debt securities at primary auctions, in particular compared to secondary market yields, are significantly limiting government borrowing. This is restraining monetary transmission, while also dampening the growth in the attractiveness of hryvnia assets, increasing the sensitivity of the FX market to situational factors and risks to financial stability in the longer term.
Fifth, the rate of emigration remains higher than the NBU’s assumptions. High emigration could threaten to reduce the labor force and have long-term negative effects on the labor market and economic growth after the war.
In view of the forecast inflation dynamics and the balance of inflation risks, the NBU Board decided to keep the key policy rate at 25%.
This decision is in line with the baseline scenario of the macroeconomic forecast. This forecast envisages keeping the key policy rate at the current level at least until Q2 2024. At the same time, the NBU is working on measures to enhance monetary transmission and minimize the negative impact of the budget’s monetary financing on inflation and the FX market.
If required, the NBU also stands ready to raise the key policy rate above its current level and to deploy additional measures to protect international reserves, as well as and to maintain control over inflation.
Thank you for your attention!