Summary of Key Policy Rate Discussion by NBU Monetary Policy Committee on 13 March 2024

Meeting date: 13 March 2024

Attendees: all 11 members of the Monetary Policy Committee (MPC) of the National Bank of Ukraine:  

• Andriy Pyshnyy, Governor of the National Bank of Ukraine 
• Kateryna Rozhkova, First Deputy Governor
• Yuriy Heletiy, Deputy Governor
• Yaroslav Matuzka, Deputy Governor
• Sergiy Nikolaychuk, Deputy Governor
• Dmytro Oliinyk,  Deputy Governor
• Oleksii Shaban, Deputy Governor
• Pervin Dadashova, Director, Financial Stability Department
• Volodymyr Lepushynskyi, Director, Monetary Policy and Economic Analysis Department
• Oleksii Lupin, Director, Open Market Operations Department
• Yuriy Polovniov, Director, Statistics and Reporting Department.

The MPC members discussed the viability of resuming the cycle of easing the interest rate policy given the positive macrofinancial trends, the stable situation in the FX market, and less uncertainty over external financing disbursements. Further FX liberalization steps to support economic recovery were the special focus of the meeting

During the discussion, it was noted that consumer inflation continued to decelerate faster than the NBU expected. In February, inflation slowed to 4.3% yoy. Favorable price dynamics were primarily driven by a greater supply of certain food products due to the effects of last year’s ample harvests and by the moratorium on raising a number of utility tariffs. Core inflation also decelerated, though less noticeably. This was in part due to less pressure from business expenses and because of a sustainable situation in the FX market.

Pressure on international reserves eased off significantly after a short-lived spike in net demand in the FX market in January–March. This was mainly made possible by more moderate budget expenditures and a faster-than-expected rise in the maritime corridor’s capacity, which expanded exports. The NBU’s active presence in the FX market, in line with the principles of managed flexibility, subdued exchange rate fluctuations in either direction, increased the FX market’s depth, and stabilized exchange rate expectations, weakening speculators’ incentives to play against the hryvnia. The tightening of currency supervision, especially measures to return FX earnings to Ukraine, also had a noticeable effect. All of this enabled the NBU to significantly reduce its interventions to sell foreign currency.

Amid a steady decline in inflation and a sustainable FX market situation, inflation expectations of most groups of respondents continued to improve. This in turn helped maintain the appetite for hryvnia instruments. In particular, households’ investments in both term deposits and hryvnia domestic government debt securities continued to grow. This further restrains the demand for foreign currency and the pressure on international reserves.

Preservation of FX market sustainability should also be facilitated by positive developments in the matter of receiving international financial assistance. At the end of February, the Council of the European Union launched a EUR 50 billion Ukraine Facility instrument for 2024–2027. It will bring Ukraine EUR 6 billion in bridge financing already in March–April. In addition, IMF staff and the Ukrainian authorities reached a staff-level agreement on the third review of the EFF Arrangement. And the Fund’s Executive Board is expected to make a decision in late March. Overall, Ukraine could receive more than USD 10 billion in March–April. This will take the volume of Ukraine’s international reserves to a new record level, bolstering the NBU’s ability to ensure exchange rate sustainability and maintain moderate inflation.

Favorable macrofinancial trends are making room for a faster-than-expected reduction in the key policy rate and for further steps to ease FX restrictions.

Five members of the MPC suggested cutting the key policy rate to 14% in March.

Inflation dynamics, the FX market situation, and lower uncertainty over international aid are better outcomes than the NBU projected and make for a good reason to loosen the interest rate policy in March already, these MPC members said. Under current conditions, cutting the key policy rate by 1 pp would pose no threats to macrofinancial sustainability, they said. At the same time, such a step would help revive lending and support economic recovery, one of the NBU’s priority tasks.

Economic uncertainty has recently subsided, making it possible to look more confidently into the future, these MPC members said. The optimism of these MPC members is fueled by the stepped-up efforts of international partners to provide financial aid, and by the renewed discussion on using frozen russian assets to Ukraine’s benefit.

One discussion participant said it remains in international partners’ interest to support Ukraine. Some delays in financing are mainly associated with electoral cycles in many Western countries. A scenario where they cease to provide funding to Ukraine is unlikely. But even in the worst-case scenario, support will probably stay above the critical level. That large foreign companies are interested in Ukrainian assets, even in the current difficult situation, is also a positive signal. It therefore is logical to expect a further revival of investment activity.

One MPC member said that some uncertainty and risks will persist in wartime. However, not all of them are adverse. Positive scenarios may also materialize. Focusing on risks and a conservative course of action may hold back economic recovery. Meanwhile, the situation is changing rapidly. Positive trends have recently emerged. It is worthwhile to take these opportunities to dynamically respond to changes in the balance of risks and facilitate economic recovery through policy easing. Even if such steps may surprise market participants.

Another participant agreed with this, saying that the NBU’s previous communications should not restrain decision-making, given that the situation is highly volatile. The NBU has always emphasized that the expected interest rate trajectory is only a forecast, not a commitment. At the same time, the NBU has repeatedly declared its readiness to respond flexibly to significant changes in the balance of risks. This is precisely what is proposed: for the NBU to seize a window of opportunity that has opened up.

Four members of the MPC supported a reduction of the key policy rate to 14.5% in March, saying such a step is sufficient at this point

The favorable macrofinancial trends are sufficiently sustainable and have presented a window of opportunity to ease monetary policy as early as March, these MPC members said. However, they said they favor a more gradual reduction of the key policy rate and that a 0.5-pp step would be sufficient at this point. The war appears set to drag on. Uncertainty about international aid remains rather high. And so, these MPC members said, the NBU should proceed with its measured and consistent monetary policy, which has proved effective.

Such a policy, amplified by favorable factors beyond the NBU’s reach, has made it possible to build a cushion of macrofinancial and external sustainability, they said. It is time to convert this margin of safety into greater adaptability of the economy to the war and into enhanced ability to recover. At the same time, it is necessary to follow the Strategy and the NBU’s previous statements, according to which the central bank will prioritize easing the most burdensome FX restrictions, rather than a quicker lowering of the key policy rate.

One of the MPC members said that the easing of restrictions should be based on the concept of additive effect for the Ukrainian economy and cover the widest possible range of companies. It is more difficult for small businesses to negotiate the restructuring of external debt, participate in legal proceedings, etc. This approach will contribute to the faster recovery of the economy, but the unintended effect may be additional costs in terms of international reserves. This is another argument for a more prudent easing of the interest rate policy.

Two other members of the MPC said the NBU should avoid deviating from market expectations by too much at the moment, given its previous communications. It is better to take a moderate step, which is more than sufficiently justified from a macroeconomic perspective and will not cause an imbalance of expectations. Such a step will simultaneously signal the NBU’s further intentions and incentivize market participants to ramp up investments in hryvnia term instruments to make the most out of the higher yield. This will restrain the pressure on the exchange rate and international reserves and create better opportunities for the government to raise funding in the domestic market, which is extremely important as uncertainty persists regarding official financing inflows.

Two MPC members called for maintaining the key policy rate at 15% in March

These discussion participants agreed that the prerequisites for easing the monetary policy could be met earlier than the January macro forecast projected. They also emphasized the importance of pursuing a careful and consistent monetary policy that is clear to market participants and that would maintain their confidence and at least partially alleviate uncertainty, which is unprecedentedly high amid the war.

Revising the macro forecast in April will make it possible to more fully assess the development of current macroeconomic trends and properly verify their sustainability. Specifically, a significant role in the current slowdown in consumer inflation has been played by the effects of temporary favorable factors, such as last year’s record harvest. In the meantime, core inflation is somewhat higher than the trajectory of the forecast the NBU made in January. In addition, exchange rate expectations remain sensitive to current exchange rate dynamics and may react to a weakening of the hryvnia.

The successful third review of the EFF Arrangement with the IMF, as well as financial assistance inflows from the EU, should not be interpreted as positive surprises. They were included in the baseline scenario of the NBU’s baseline macro forecast, these MPC members said. Concurrently, the risk materialized of irregularity of financial aid disbursements from the United States that were expected to arrive in February 2024. Uncertainty regarding the amount of such aid will continue into the future. There are also risks that additional budgetary needs may arise to maintain the defense capability.

The probability that less favorable scenarios than the baseline one become reality remains rather high, according to these discussion participants. The NBU should therefore be prudent in its assessment of the lower inflation rate, smaller FX intervention volumes, and the anticipated high level of reserves. Given what has already happened, it is advisable to look ahead and take into account the lagged effects of current decisions. Provided there is confidence about a positive development of events, it is recommended that the central bank use the available wiggle room to loosen the monetary policy primarily for FX liberalization purposes. 

Communication is an important component of monetary decision-making. According to polled market participants, keeping the key policy rate unchanged is currently the most anticipated and appropriate decision. At the current meeting, we should therefore limit ourselves to articulating forward guidance on a possible reduction of interest rates by the NBU sooner than predicted in the January macro forecast. This will make it possible to avoid surprising the market, substantiate in detail the reasons for future rate cuts, and generate appropriate expectations to prevent potential adverse responses. In particular, a rushed easing of the interest rate policy may lower the attractiveness of hryvnia instruments as a means of making savings.

The vast majority of MPC members supported a more significant reduction in interest rates on three-month certificates of deposit (CDs) and refinancing loans 

Transactions with three-month CDs, at an increased interest rate and with limits tied to how much the banks expand their portfolios of hryvnia retail term deposits, remain an important element of the policy of maintaining the attractiveness of hryvnia instruments, discussion participants said. In use for almost a year now, this tool has proved itself and fueled the banks’ competition for depositors even amid extremely high liquidity. At the same time, under the conditions of the cycle of interest rate policy easing and the sustained pullback in inflation, the need to maintain a significant difference between the three-month interest rate and the key policy rate is declining. With this in mind, most MPC members advocated for narrowing this gap.

Specifically, several MPC members offered to reduce the spread between the key policy rate and the three-month interest rate by 0.5 pp. Such a cautious move, they said, would make it possible to assess the cumulative transmission from the simultaneous reduction of the key policy rate and the narrowing of the spread (incorporating the multiplier effect) in rates on hryvnia term deposits. This would help maintain better controllability of the loosening of monetary conditions and the right level of attractiveness of hryvnia deposits.

Most MPC members supported a narrowing of said spread by 1 pp in one step, to 3 pp from 4 pp. Such a move, they said, would not undermine the banks’ incentives to continue to compete for depositors.

The preservation of incentives will also be facilitated by the planned changes to the formula for calculating the cap on the banks’ investments in three-month CDs. Specifically, from 19 April forward, the increase in hryvnia retail deposits with more than 93 days’ maturity will be calculated for the last 12 months, not from 4 April 2023, as is the case now. Therefore, to maintain their ability to further invest in three-month CDs, the banks will need to ramp up their portfolio of new retail term deposits.

Several MPC members said that the urgency of fueling the banks’ competition for depositors is declining against the backdrop of the interest rate policy easing. It therefore makes sense, at the moment, to reduce the spread more substantially and keep transactions with three-month CDs in the NBU toolkit in a more “passive state.” Should adverse macroeconomic scenarios materialize that require a tightening of monetary policy, the NBU will be able to strengthen the stimulating effect of this instrument by expanding the spread accordingly.

Considering the general context of loosening the interest rate policy, most discussion participants also spoke in favor of additionally lowering the interest rate on refinancing loans to 19%–19.5%.

By contrast, one MPC member said it is viable to considerably narrow the spread between the key policy rate and the refinancing rate to 4 pp. This will contribute to the development of the domestic debt market by making it more comfortable for the banks to purchase domestic government debt securities. The banks will be aware that if a short-term liquidity deficit occurs, they will be able to cover it through refinancing loans at a lower cost.

All MPC members said they see room for further cuts to the key policy rate in 2024, although opinions differed on the pace of the interest rate easing

Several MPC members said they do not rule out a lowering of the key policy rate to 11%–12% during the current year. This rate level will be consistent with the anticipated moderate pace of inflation in the coming years and should not lead to loss of attractiveness of hryvnia assets and an imbalance of expectations, they said. The forecast should draw on balanced assumptions, as the economy has largely adapted to the war, and international support will continue, these MPC members said. Amid a longer duration of security risks, the economy will need additional incentives for recovery, and a more active reduction of the key policy rate will make it possible to revive lending.

In contrast, most discussion participants expect a decrease in the key policy rate to 13%–14% by the end of this year. The scope for loosening the interest rate policy is limited, they said, considering the expected acceleration of inflation in H2 2024, the elevated probability that high security risks persist into the next year, and risks associated with the regularity and volume of external financing, among other things. The implementation of plans to press forward with FX liberalization is an additional factor that will limit the size of a one-step reduction in the key policy rate.

Under such conditions, the NBU should proceed with caution, keeping hryvnia assets sufficiently attractive without triggering more pressure on international reserves, according to these MPC members. A more material reduction in the key policy rate can be considered only on the condition that significant positive changes take place in the current balance of risks, specifically with regard to international financial assistance.