Summary of a Key Policy Rate Discussion by the NBU Monetary Policy Committee on 3 March 2021

Date of the meeting: 3 March 2021.
Attended by eight out of ten members of the Monetary Policy Committee (MPC) of the National Bank of Ukraine:

• Yurii Heletii – acting Governor
• Kateryna Rozhkova – First 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
• Yurii Polovniov – Director of the Statistics and Reporting Department. 

During the meeting, the MPC members paid particular attention to rising inflationary pressures amid the revival of the global and Ukrainian economies. 

The participants noted that inflation had sped up noticeably in early 2021. More specifically, in January, as expected, inflation overshot the upper boundary of the target range of 5% ± 1 pp. In February, according to the NBU’s online monitoring data, consumer prices rose at a faster pace than envisaged in the baseline macroeconomic forecast (The January 2021 Inflation Report). 

The Ukrainian economy continued to recover. The 2020 GDP fall (by 4.2%) turned out to be less pronounced than expected at the onset of the coronavirus crisis (by 6%). The adverse impact of the stricter quarantine restrictions imposed in January on the economy was only temporary. Business sentiment improved significantly right after the January lockdown was lifted. In particular, in February industrial companies reported positive expectations of their business performance, for the first time in the last four months. The expectations of the trade and services sectors almost reached the equilibrium level. The global economy is also rebounding on the back of the rolling out of vaccination campaigns and large-scale stimulus programs. 

The MPC members said that pro-inflationary risks had increased for the baseline inflation scenario. Prices on the global commodity markets, such as energy and food prices, are rising at a faster pace than expected. Inflationary pressures from Ukraine’s trading partners are increasing, driven by the economic recovery in these countries and depreciation effects in some countries. 

Internal underlying pressures have also intensified, as expected. Despite tight quarantine restrictions, retail trade turnover grew by 3.5% yoy in January. Compared to last year, Ukrainians are spending more on buying goods online. Inflation expectations remain elevated.

In contrast, the inflow of foreign capital into government securities in January – February had no noticeable disinflationary effect through the exchange rate channel. The overall supply of foreign currency only slightly exceeded demand, as a result of which the hryvnia failed to strengthen noticeably. In the last weeks of February, foreign investors’ interest in domestic debt government securities waned, due to, among other things, the rising yields of advanced economies’ bonds. 

The participants also pointed to uncertainty factors that could have a significant impact on inflation. These are mainly the pace at which vaccination campaigns are rolled out and the pandemic is overcome. These factors will affect future consumer demand and the pace at which business activity, in particular investment activity, recovers. Fiscal stimulus parameters will also remain important inflation factors. In addition, it is still unclear what effect the large-scale stimulus of the global economy will have, as this effect might only become apparent over time. 

Six MPC members spoke in favor of raising the key policy rate to 6.5%, in line with the baseline scenario of the NBU’s macroeconomic forecast. 

In their opinion, currently there is no sufficient reason to deviate from the baseline scenario. The rise in inflationary pressures in H1 2021 was expected. Core inflation movements are close to the projected trajectory. The need to raise the key policy rate to balance inflation expectations was announced earlier, while the 0.5 pp increase on the whole corresponds to market expectations. 

One of the participants pointed to divergent factors that have a bearing on inflation. On the one hand, global market conditions have pushed inflation above its projected trajectory. On the other hand, vaccination campaigns are being rolled out slowly and a third wave of the pandemic is sweeping over the world. Ukraine has also seen a rise in morbidity, which is generating the risk of a cooling in consumer demand and in the economy as a whole. In this light, this participant believes that the best possible course of action is to wait until the April monetary policy meeting takes place and a revised macroeconomic forecast is made, and then make a decision to correct the key policy rate forecast. This participant also said that at that time there would be more clarity about how the new wave of the pandemic was developing, the conditions of the global commodity markets, and how negotiations with the IMF were proceeding.

Another MPC member said that the world was entering a post-crisis recovery stage, and that the situation had some similarities to that in 2005. There is a surfeit of liquidity globally, foreign investors are looking for profitable assets, capital is flowing into developing countries, and household income and consumption are rising. Therefore, price growth on the global markets is not temporary, and external inflationary pressures will persist. Judging by the expected terms for the completion of the vaccination campaigns in advanced economies, these pressures could even intensify in H2. All this could adversely affect inflation expectations in Ukraine, as these expectations have not been sufficiently anchored. Under such conditions, a rise in the key policy rate is a logical step. Conversely, it would take longer to restore confidence in monetary policy if a decision were delayed. 

Another participant said that despite a key policy rate rise, monetary policy would remain accommodative. Given high inflation expectations (analysts expect consumer prices to rise by 6.7% over the next 12 months), the real key policy rate remains in negative terrain, and below its neutral level. In this light, the NBU’s monetary policy continues to contribute to the economic recovery. 

Another participant said that a 0.5 pp rise was a well-weighted decision. It balances the need to decrease inflationary pressures and stabilize inflation expectations against the need to support an economy that has just overcome a crisis. Conversely, too sharp an increase could damage the economy. The participant stressed that leading central banks are relying on the flexibility of the inflation targeting regime to prevent economic losses, and that the NBU should also follow their example. 

Two MPC members spoke in favor of raising the key policy rate to 7%. 

One of them said that the January increase in retail trade turnover (in annual terms) despite the two-week lockdown once again proved that consumer demand was rebounding rapidly, and that the economy was resilient to the coronavirus crisis. This trend will persist, propped up by a further increase in household income and spending, and substantial growth in savings during the pandemic that could be spent later. 

The participant added that the global financial markets were gradually arriving at a consensus about a further rise in interest rates in advanced economies. At the same time, interest rate increases in emerging markets – to which Ukraine belongs – will be more pronounced due to rising risk premiums. In early 2021, central banks in several emerging markets changed their rhetoric in favor of a tighter monetary policy. There was also an increase in the number of central banks that expect faster inflation. In view of the above, the NBU should also give a clear signal to market participants that it stands ready to prevent a spike in inflation, by raising its key policy rate by 1 pp. This participant believed that delaying this decision made no sense, as this would only increase uncertainty. 

Yet another participant said that the global economy was recovering more quickly and global commodity prices were growing faster than expected. Expectations of a spike in inflation and an increase in interest rates, following a year of extremely loose monetary and fiscal policies, are rising globally. Higher premiums for Ukrainian credit default swaps indicate that financial market players are concerned. The NBU’s failure to respond appropriately to the rapid growth in prices could unbalance inflation expectations. The participant held the view that a 0.5 pp increase in the key policy rate was an insufficient preventive measure. 

The MPC members agreed that the NBU would have to continue to increase its key policy rate in order to decrease underlying inflationary pressures and to balance expectations. 

Four MPC members believed that raising the key policy rate to 7% and maintaining it at that level until the end of the current year was a sufficient step. Other members said that this would not be enough to decrease underlying inflationary pressures, and that the NBU might have to raise its key policy rate more decisively. Meanwhile, all MPC members agreed that the projected trajectory of the key policy rate could be adjusted in the April macroeconomic forecast, taking into account any materialized risks and uncertainty factors. 

The decision to set the key policy rate at 6.5% per annum was approved by the NBU Board at the monetary policy meeting held on 4 March 2021.