Date of the meeting: 29 January 2020.
Attendees: All ten members of the NBU Monetary Policy Committee (MPC):
- Yakiv Smolii - Governor of the National Bank of Ukraine
- Kateryna Rozhkova - First Deputy Governor
- Roman Borysenko - Deputy Governor
- Dmytro Sologub - Deputy Governor
- Sergii Kholod - Deputy Governor
- Oleg Churiy - 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
- Serhii Ponomarenko - Director of the Open Market Operations Department.
It was unanimously agreed at the meeting that the projected trajectory of the key policy rate should be revised so that policy rate cuts in 2020 can be deeper than predicted in the previous macroeconomic forecast published in the October 2019 Inflation Report. Specifically, all MPC members called for significant cuts to the key policy rate as early as this year’s first monetary policy meeting of the NBU Board.
Inflationary pressures in 2020 are easing more quickly than previously expected, the MPC members pointed out. In January, for instance, inflation fell below the target range of 5% ± 1 pp, the NBU estimates. Inflation expectations have continued to improve as well. With energy prices still relatively low and the fruit and vegetable harvests projected to increase, consumer inflation will continue to be restrained by the effect of last year’s strengthening of the hryvnia. As a result, inflation will stay below its target range for most of 2020.
Under these conditions, monetary policy should aim to bring inflation closer to the medium term goal of 5%, which is optimal, given the need to catch up with neighboring countries in terms of the level of the population’s standard of living, the MPC members said. At least as important is that the monetary policy easing supports economic growth and the decline in the cost of borrowing.
At the same time, the MPC members differed on the size of the January key policy rate cut.
Six MPC members agreed that the key policy rate should be reduced by 200 bp, to 11.5%.
A 200 bp cut is a viable option, these MP members believe. Although the NBU expected slower growth in consumer demand, it will continue to grow at a high rate, driven, among other things, by a further increase in wages and the persistent effect of pent-up demand following the 2014–2015 crisis, the six MPC members pointed out. Lowering the key policy rate too aggressively thus risks accelerating inflation in 2021 to a level above the target range. In that case, the NBU will have to suspend its monetary policy easing or even tighten its monetary stance. Such a policy reversal may make it harder for economic agents to understand the NBU’s logic and could compromise public confidence in the NBU.
Key risks to the NBU’s projections continue to exist, the MPC members added. Those include delays in signing a new cooperation program with the IMF and heightened threats to macrofinancial stability as Ukrainian courts issue rulings. Apart from that, while the spread of the new coronavirus has up thus far fallen short of becoming a major long-term factor affecting Ukraine’s macroeconomic and financial stability, it could potentially be one of the risks to the realization of the the macroeconomic forecast, the MPC members pointed out. The global spread of the virus may only have a short-lived effect on Ukraine, depressing exports, such as metals, and by temporarily restricting the nation’s access to external financing, current estimates say.
A gradual reduction of the key policy rate, these MPC members believe, is also preferable in that it would help introduce households and businesses to a new economic reality in which interest rates on deposits are in single digits. Deep interest rate cuts may slow the inflow of term deposits to the banking system. In contrast, a gradual lowering of the key policy rate will enable the banks to synchronize their interest rate policies with monetary policy changes, and will make it easier for individuals and businesses to make investment decisions.
The reversal in exchange rate developments that took place in late December may worsen inflation expectations, one of the MPC members said. Although inflation expectations declined significantly in 2019, they are still anchored rather weakly and are sensitive to exchange rate changes. This is especially true for households. A weaker hryvnia could prevent inflation expectations from further approaching the NBU’s inflation target and may even reverse the trend. A worsening of inflation expectations may, in turn, increase inflationary pressures.
Two MPC members advocated a cut in the key policy rate by 250 bp, to 11.0%.
Given that inflationary pressures have eased substantially, the NBU should make a deeper key policy rate cut, two MPC members said.
In January, the hryvnia’s volatility did not breach acceptable bounds, meaning that its impact on inflation expectations will be limited, these MPC members believe.
In addition, a more radical cut to the key policy rate poses no significant risks to the banks’ deposit inflows, as the transmission of key policy rate changes to the banks’ interest rates occurs with a lag. The banks will be reluctant to lower interest rates sharply, especially those on retail deposits, for fear of losing customers.
What is more, reducing interest rates on deposits does not always hamper deposit inflows, FX deposits data suggests. Despite there being a significant drop in the rates on these deposits, their volume increased in 2019. As with FX deposits, hryvnia deposits would continue to be an attractive financial instrument even if interest rates on these deposits were to be reduced. With inflation at a sufficiently low level, hryvnia deposits will yield a higher real return than FX deposits.
Cutting the key policy rate by more than 250 bp at a time is impractical, these MPC members also argued. Doing so would surprise the market and impair economic agents’ current understanding of the NBU’s policy response to economic developments in Ukraine.
Two MPC members suggested cutting the key policy rate by 350 bp to 10%.
The delayed effect of several factors has created substantial risks of inflation falling below the projected trajectory, these MPC members said. The main factor is the decision to revise administered prices and tariffs in light of the relatively low cost of natural gas. Certain antitrust measures will also restrain inflation. Consumer prices will continue to reflect these factors, enabling the NBU to take decisive steps to ease its monetary policy, the two MPC members argued.
As they reviewed the projected trajectory of the key policy rate in the coming years, the MPC members were more unanimous.
Most MPC members approved the new projected trajectory of the key policy rate, which the updated forecast says will decline to 7% in late 2020 and remain close to this level in the years ahead, provided that inflation stabilizes in the target range.
Some MPC members said further cuts to the key policy rate should be smaller. Continuing to actively reduce the key policy rate may dampen nonresidents’ appetite for hryvnia assets, these MPC members believe. This will trigger depreciation pressure on the hryvnia, worsening inflation expectations.
Deep key policy rate cuts may weaken households’ propensity to save, one of the MPC members suggested. As rates on term deposits approach single digits, households may have fewer incentives to make bank deposits.
The decision to set the key policy rate at 11.0% per annum was approved by the NBU Board at a monetary policy meeting held on 30 January 2020.
For reference:
The Monetary Policy Committee (MPC) is an NBU advisory body that was created to share information and opinions on monetary policy formulation and implementation, in order to deliver price stability. The MPC comprises the NBU Governor, other NBU Board members, and directors of the Monetary Policy and Economic Analysis, Open Market Operations, Financial Stability, and Statistics and Reporting Departments. The MPC meets the day before the NBU Board meeting on monetary policy issues. Decisions on monetary policy issues are made by the NBU Board.