Summary of Key Policy Rate Discussion by NBU Monetary Policy Committee on 24 January 2024

Meeting date: 24 January 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 macroeconomic forecast scenarios and the adequacy of monetary policy measures to maintain exchange rate sustainability, keep inflation subdued in 2024, and bring it into its target range in 2025. A specific focus was placed on risks associated with the war and uncertainty over international financial assistance. 

In December, consumer inflation remained at 5.1% yoy, while core inflation continued to slow to 4.9% yoy. Price dynamics at the end of the year came out better than the NBU’s previous forecast projected (October 2023 Inflation Report). The faster decline in inflation was largely due to the effects of the high harvest, which restrained the growth in food prices. The moratorium on tariff increases for certain utilities played an important role in restraining inflationary pressure. The NBU’s monetary policy measures to maintain exchange rate sustainability also had a significant impact on reducing inflation. Thanks to the NBU’s interventions, the FX market situation remained under control, while efforts to keep hryvnia-denominated assets attractive restrained the demand for foreign currency. Maintaining a fairly sustainable situation in the FX market in turn helped improve inflationary expectations and impede the growth in prices for a wide range of goods with an import component.

Fundamental price pressures persist in spite of the above. The war’s adverse impact on inflationary processes remains significant, in part due to businesses’ increased costs of logistics and electricity, reconstruction of destroyed production facilities, and readjustment of manufacturing processes. The impact of the cost of labor on companies’ pricing decisions is also rising. The lack of qualified workers amid significant migration and mobilization processes encourages businesses to raise wages, an increase that eventually passes through to consumer prices. This is evidenced by the rather high pace of growth in services prices. In addition, the economic recovery is accompanied by a revival of consumer demand, which puts more pressure on prices.

The favorable effects of temporary factors, such as last year’s ample harvest, that reduce inflationary pressure are also tapering off. Specifically, a shrinking supply of quality products is already affecting raw food prices as warehouses run into space shortages and high costs of storage. What is more, the NBU anticipates a certain decline in the volume of the harvest this year after last year’s record yields, an expectation that is primarily driven by extremely favorable weather conditions. Accordingly, although food inflation stands to remain moderate, it is expected to be higher than last year. On top of that, even though the moratorium on raising certain utility tariffs is still in place, administered inflation is set to remain significant, primarily due to the planned increase in excise taxes on alcohol and tobacco products.

Considering the totality of these factors, the NBU projects a temporary acceleration of inflation to 8.6% in 2024. Risks to this forecast are rather tangible, given the country’s tremendous defense needs and elevated uncertainty over international financial assistance for this year and the next. The NBU’s forecast envisages a gradual rollback of external financing, but assumes that significant amounts of aid will keep flowing in. Specifically, the disbursement of about USD 37 billion in loans and grants is expected in 2024. However, the amount noted above has yet to be confirmed by international partners. Such delays are currently having no outright consequences for Ukraine’s macrofinancial stability, thanks to the accumulated margin of safety, but they may threaten to degrade economic resilience in the medium term. Delays in financing are already having an adverse impact on economic agents’ expectations, which has been driving up FX demand, among other things. 

The MPC members unanimously supported maintaining the key policy rate at 15%

The discussion participants agreed that the NBU should proceed with caution, given that the projected rise in inflation in 2024 is likely to affect expectations. It is also worth taking into account the intensification and partial materialization of risks to the rhythm and volumes of international aid inflows. Under these conditions, it is important to pursue a prudential, consistent, and predictable monetary policy to maintain subdued price dynamics, reduce uncertainty, and avoid an imbalance of expectations. This in turn is necessary for ensuring financial stability and supporting economic recovery in wartime.

Preserving exchange rate sustainability will continue to be an important means of carrying out these tasks. Meanwhile, after the cancelation of the exchange rate peg and during the further increase in exchange rate flexibility, inflation should gradually take back its role as a nominal anchor of monetary policy. To this end, it is important to keep inflation moderate in 2024 and bring it into its target range of 5% ± 1 pp in 2025.

Although inflation will accelerate this year, driven primarily by shocks beyond the reach of monetary policy (such as a lower harvest and higher excise taxes), the NBU should also take into account the effects of the revival of domestic demand and the possible deterioration of inflationary expectations, which will fuel price pressure, one MPC member said. In this regard, the NBU’s consistent measures, including the maintenance of a sufficiently high key policy rate, are what will keep inflation at single digits and return it to its target over the policy horizon.

Another participant agreed with this, saying that a fairly tight interest rate policy should complement the NBU’s arsenal of tools for maintaining exchange rate sustainability. The NBU’s active presence in the FX market is a strong prerequisite for sustainability, but FX interventions deplete international reserves. To curb the demand for foreign currency and preserve international reserves at a high level, it is important to maintain sufficiently high interest rates on hryvnia instruments, which will protect households’ hryvnia savings from losing value as prices rise. Keeping the hryvnia attractive is a particularly urgent task amid delays in foreign aid and a worsening of exchange rate expectations.

Another MPC member said that leaving the key policy rate unchanged is a logical step, even from the perspective of increasing risks of a longer and more intense war than is currently assumed. A longer persistence of high risks to security will generate additional price pressure not only by actually increasing businesses’ logistical costs and employee compensation and rebuilding destroyed capacities, but also through the expectations channel. A longer-lasting war will also add to pressure on public finances and require more of domestic borrowing. The unfolding of such a scenario will probably require a tightening of the interest rate policy to preserve macrofinancial stability. The NBU should therefore act carefully.

One MPC member said that not changing the key policy rate would be a consistent and predictable decision. It matches the baseline scenario of the macroeconomic forecast,  the NBU’s previous statements on its intentions, and the Strategy for Easing FX Restrictions, Transitioning to Greater Flexibility of the Exchange Rate, and Returning to Inflation Targeting in terms of fulfilling the NBU’s tasks to maintain the attractiveness of hryvnia instruments and ensure exchange rate sustainability. According to surveys, most experts and market participants expect the key policy rate to remain unchanged in January. They consider such a decision optimal.

The MPC members said there is room, though limited, for cutting the key policy rate in 2024 

The NBU will be able to return to making key policy rate cuts in H2 2024 if the macroeconomic situation closely follows the baseline scenario and if the rhythm of international financing inflows is restored, the MPC members said. Under such conditions, a moderate easing of interest rate policy will not disrupt the sustainability of the exchange rate and the return of inflation to the target range over an acceptable policy horizon, but will support lending development and economic recovery. The vast majority of discussion participants said they expect the key policy rate to be 14% at the end of the year, while several MPC members said it will decline to 13%.

The discussion participants agreed, however, that the NBU should stand ready to adjust its monetary policy if the balance of risks to inflation and economic development is changed. With uncertainty rising, especially as regards the course of the war and support for Ukraine, a revision of the key policy rate trajectory over the entire forecast horizon is rather likely. It would maintain the right monetary conditions.

Several MPC members said that closer to mid-2024, the NBU will be able to more accurately assess how realistic the main assumptions in the forecast for 2024–2026 are, and will incorporate this assessment in its further decisions regarding the key policy rate while taking proactive action.