Summary of Key Policy Rate Discussion by NBU Monetary Policy Committee on 16 June 2021

Date of the meeting: 16 June 2021.
Attendees: all ten members of the Monetary Policy Committee (MPC) of the National Bank of Ukraine:

• Kyrylo Shevchenko, NBU Governor
• Kateryna Rozhkova, First Deputy Governor
• Yuriy Heletiy, Deputy Governor
• Yaroslav Matuzka, Deputy Governor
• Dmytro Sologub, Deputy Governor
• Oleksii Shaban, Deputy Governor
• Vitalii Vavryshchuk, Director of the Financial Stability Department
• Volodymyr Lepushynskyi, Director of the Monetary Policy and Economic Analysis Department
• Oleksii Lupin, Director of the Open Market Operations Department
• Yurii Polovniov, Director of the Statistics and Reporting Department. 

During the meeting, the MPC members paid special attention to the role of fundamental and temporary factors in driving the increase in inflationary pressures. 

Inflation in May 2021 came out higher than in the NBU’s forecast, the discussants pointed out. The CPI grew by 9.5% yoy, and the core CPI by 6.9% yoy. The change in the cost of the consumer basket was primarily driven by the rise in prices for some of the CPI’s highly volatile components, including natural gas, sunflower oil, and sunflower oil products. These price increases were mainly due to short-term factors. 

Consumer demand remained stable, as evidenced by large increases in retail trade, consumer imports, and car sales, and by an upward trend in the number of flights. The growth in household incomes fueled the recovery in consumption. 

At the same time, there are certain signs that underlying inflationary pressures did not surpass the NBU’s projections.

Ukraine’s economic recovery in early Q2 continued, even after accounting for last year’s low comparison base. Specifically, seasonally adjusted indicators increased in April in most sectors of Ukraine’s economy, such as retail trade, construction, and industry. The growth in industry, in particular, was driven by high global prices for metals-and-mining products. Business outlook improved, while the labor market revived noticeably, including labor demand. 

The global economy also recovered rapidly, spurred by widespread vaccination, massive stimulus injections, and increasingly upbeat sentiment. At the same time, global commodity prices remained high amid sustained demand and a limited supply. Against the backdrop of rising energy and food prices, inflation in Ukraine’s major trading partners continued to accelerate. 

The measures the NBU has taken to ease inflationary pressures are already taking effect. On the one hand, previous key policy rate increases have so far had a limited impact on market interest rates, in particular due to the high level of bank liquidity and lags in monetary transmission. 

On the other hand, these rate hikes have amplified the impact of the exchange rate channel and the expectations channel. Specifically, the hryvnia strengthened significantly, in part due to the resumption of nonresident portfolio investment inflows. 

Exchange rate and inflation expectations of businesses and households have slightly improved (barring the results of the April survey, which was conducted with a change of methodology due to stricter quarantine measures). Analysts’ inflation expectations have deteriorated slightly, but are close to the NBU’s inflation forecast. 

Seven MPC members called for maintaining the key policy rate at 7.5% 

Inflation risks have risen since the NBU’s last monetary policy decision, these MPC members agreed. However, the current decision should take into account that supply factors, mainly short-term in nature, significantly accelerated inflation in May. A surge in the prices of some consumer basket components – such as natural gas and sunflower oil – should not automatically trigger a monetary response by the NBU. Especially since inflation is expected to slow in the autumn as the effect of the low comparison base fades and the new harvest arrives. 

In addition, inflation expectations of households and businesses in recent months have stabilized somewhat, indicating positive sentiment. A stronger hryvnia and the fading of the psychological effects of price increases that have already happened will also help improve expectations further.

Market interest rates have been slow to respond to the last two key policy rate hikes, some of the discussants said. It is thus more logical to amplify monetary transmission by rolling back the anti-crisis monetary measures, including long-term refinancing, these discussants argued. Therefore, they said, a key policy rate revision is best postponed until July, when there is a fresh macroeconomic forecast and when greater certainty emerges about the dynamics of global commodity and financial markets. 

Another discussant drew attention to the unusual nature of the new global economic cycle. This cycle has been characterized by significant supply shocks (mainly the result of administrative actions), low interest rates, and a limited capability of central banks to control inflation, this MPC member said. Under normal conditions, it would be possible to respond to these inflationary factors by raising the key policy rate to subdue demand to a level that meets a lower supply. However, with the interest rate channel of monetary transmission being inert, inflation would be better curbed through the exchange rate channel, this discussant suggested. 

This makes it important to continue to pursue the flexible exchange rate regime. Going forward, should FX supply surpass demand, it is important not to restrain a moderate revaluation amid rising export sales and reviving investor interest in domestic government debt securities.

Three MPC members suggested raising the key policy rate to 8%

The key policy rate is much lower than its neutral level, meaning that the NBU’s monetary policy is still accommodative, said one of the discussants. At the same time, the economy is already recovering, and inflation needs to be kept in check. This indicates the need for an appropriate and consistent response by the NBU towards the normalization of monetary policy. 

Several discussants questioned the suggested short-lived nature of the current inflationary shock. Developed countries usually rebound from recessions quickly, and this will have a direct effect on Ukraine. Given the global trends, it may be difficult for the NBU to return inflation to its target over the monetary policy horizon (9–18 months).

In the face of a significant increase in inflationary pressures and long-term uncertainty around negotiations with the IMF, raising the key policy rate is a logical and consistent step, several MPC members said. Meanwhile, the nonresident portfolio investment inflows that are making the hryvnia stronger may be a short-term factor. 

In addition to temporary pro-inflationary factors, there is also sustained consumer demand in Ukraine, said one of the discussants. Central banks in EMs are now actively moving towards the normalization of their monetary policies. And although the NBU has been one of the world’s first regulators to raise the key policy rate this year, the market anticipates that the Ukrainian central bank will continue to respond to further deviations of inflation from its target and its forecast trajectory. 

One can expect a certain positive effect from the revaluation of the hryvnia, but using these expectations to justify keeping the rate unchanged would be wrong, this MPC member said. Previous key policy rate changes have not yet been fully reflected in market rates, this MPC member added. The elasticity of market interest rates with respect to the key policy rate may have declined, in part due to a long period of disinflation. However, monetary transmission always works with a lag: deposit rates have already stopped falling, and a reversal should begin in the coming months. 

The probable acceleration of inflation to double digits, even one driven by purely short-lived factors, threatens to create a nonlinear imbalance of expectations, several discussants suggested.

There was a fifty-fifty split between the MPC members over the projected trajectory of the key policy rate 

The NBU will have to further raise the key policy rate this year to ensure that inflation returns to its 5% target in 2022, five MPC members proposed. In contrast, the other half of the MPC did not rule out that previous key policy rate hikes and the rollback of anti-crisis monetary measures may prove sufficient to ease inflationary pressures. 

The decision to keep the key policy rate at 7.5% per annum was approved by the NBU Board at the monetary policy meeting held on 17 June 2021.