KMP members discussed the prerequisites, risks and further measures to avoid emission financing of the budget deficit, strengthen the stability of the foreign exchange market and reduce inflation
During the discussion, it was noted that inflationary pressure shows signs of stabilization, but at a high level. In recent months, the inflation rate in annual terms has hardly changed, and according to the results of 2022 was 26.6%. The annualized seasonally adjusted monthly change in consumer prices has also fluctuated in the horizontal range of 25-30% in recent months. An important factor in the stabilization of inflationary pressure was the increase in the supply of food products and the de-occupation of territories, in particular parts of the Kherson region. The improvement of logistics in liberated cities and towns contributed to the reduction of prices in these regions.
The fixed official exchange rate, supported by administrative restrictions and currency interventions by the NBU, became the main anchor for stabilizing expectations and price dynamics. The NBU’s measures to calibrate currency restrictions and create additional opportunities to protect savings additionally contributed to the strengthening of the hryvnia in the cash segment of the foreign exchange market at the end of the year. This, in particular, made it possible to generally stabilize inflation and exchange rate expectations. The foreign exchange market remained stable even in the face of increased terrorist attacks by Russia.
Inflation was restrained to some extent by the demand factor as a result of Russia’s missile attacks against the energy infrastructure. This is, in particular, related to the redistribution of consumer spending in favor of goods necessary for passing the heating season in conditions of regular power outages, which are widely represented in the basket of the consumer price index. In the future, the growth of prices was hampered by such factors as the establishment of logistics, as well as unchanged tariffs for housing and communal services (ZhKP).
Consumer price growth is expected to moderate in 2023 due to tight monetary conditions, lower global inflation and weaker demand. At the same time, the risks to the inflation forecast remain elevated, primarily due to the possibility of a longer persistence of security risks, which may be accompanied by further destruction of infrastructure and production capacities, problems with logistics and electricity shortages.
Thus, the operation of the “grain corridor” is in a permanent risk zone, and missile terror from Russia can cause more significant imbalances in the energy system. All this threatens a reduction in the supply of certain goods, an additional increase in production costs, and a decrease in the revenue of enterprises, including currency revenue. Under such conditions, it is also likely that budget revenues will not be received and that additional costs will be incurred to support the defense capability and the social sphere. This, among other things, leads to the preservation, although not high, of the risk of resuming budget monetization, which was planned to be stopped from the beginning of 2023. Volumes of international aid and domestic debt market involvement should be sufficient to avoid this scenario, but the risk of irregularity of these revenues remains.
Early signs of stabilization of inflation expectations also do not give cause for excessive optimism. The current values of inflation expectations of certain groups of respondents are close to the maximum values in previous crisis periods, and the medium-term expectations of some of them have recently continued to deteriorate. In the conditions of still elevated exchange rate expectations and a significant “canopy” of liquidity, the sensitivity of the financial system to situational factors remains high. Therefore, taking into account the revision of the assumption regarding the duration of the preservation of security risks and terrorist actions of Russia, there remains a threat of increasing exchange rate pressure, fixing inflation at a high level or even further unfolding of the “inflationary spiral”.
Taking into account the above, the members of the KMP for the fifth time in a row unanimously spoke in favor of maintaining the accounting rate at the level of 25%
Under the current conditions, maintaining the discount rate at the level of 25%, according to the members of the KMP, is the optimal solution from the point of view of ensuring exchange rate stability and the return of inflation and expectations for a steady downward trajectory. This decision takes into account the balance of risks over the forecast horizon, including the uncertainty and challenges that may be generated by a possible intensification of hostilities.
The maintenance of the discount rate is also consistent with the previous communications of the NBU and meets market expectations. One of the members of the KMP emphasized that this decision is fully correlated with the obligation stipulated in the memorandum with the IMF in terms of continuation of monetary policy aimed at easing price pressure and increasing the attractiveness of hryvnia assets.
Most of the participants in the discussion, as was the case at previous meetings of the KMP, do not see the prerequisites for reducing the discount rate during 2023
The majority of CMP members consider the basic forecast of the discount rate to be realistic, with its maintenance at the level of up to 25% at least until the 1st quarter of 2024. In their opinion, maintaining the rate at a high level will contribute to the strengthening of monetary transmission and the achievement of the NBU’s goals of increasing the attractiveness of hryvnia assets and improving the term structure of deposits in the banking system.
Several of these panelists noted that it is too early to signal any more rapid easing of monetary policy. In their opinion, the risks to inflation remain shifted upwards. In the case of their implementation, there will be a need for additional strengthening of monetary conditions, and then a premature announcement of a possible softening of monetary policy may undermine the confidence of market participants in the NBU’s decisions and lead to a deterioration of expectations. In addition, premature signals about softening of monetary policy may restrain monetary transmission, and accordingly, the sensitivity of the financial system to situational factors will remain elevated.
Another KMP member emphasized that even under the current forecast of the discount rate, inflation will remain above the target range until at least the end of 2025, in particular due to the need to adjust utility tariffs after reducing security risks. Such a long stay of inflation at high levels, even despite the significant influence of non-monetary factors, will increase the threat of unbalancing inflationary expectations. Therefore, the issue of softening of monetary policy and communication of such decisions should be approached very carefully so as not to shake the confidence in the NBU’s actions.
Instead, several participants in the discussion believe that the probability of a significant strengthening of monetary policy is low. In addition, in their opinion, the cycle of lowering the discount rate may begin somewhat earlier than the updated forecast suggests. In particular, one of them noted that price pressure this year may turn out to be lower than currently expected, as a result, in particular, of a more significant weakening of consumer demand, a faster slowdown in global inflation, and the maintenance of utility tariffs for the population at a low level.
The participants of the discussion supported further measures to strengthen the competition of banks for time deposits, in particular, the next stage of increasing the mandatory reserve requirements (OR)
The participants of the discussion noted that the NBU’s previous measures to strengthen the monetary transmission, including adopted in December to increase the norms of OR on current and demand accounts, supported the further increase in rates on hryvnia deposits. Thus, the growth trajectory of rates on hryvnia time deposits of households, weighted by the volume of new investments at such rates, remains close to the model trajectory of the pre-war response to changes in the discount rate. At the same time, in October – December, the growth of the Ukrainian rate index for deposits of individuals slowed down, during the calculation of which volume weighting is not applied. According to one of the participants in the discussion, this shows that the volume of attracting new term deposits increases primarily by those banks that offer depositors more attractive conditions. Therefore, even in the conditions of a full-scale war, the interest rate on hryvnia assets retains a significant value for making decisions about savings.
In response to the rise in interest rates, the share of time deposits in the total volume of new hryvnia deposits of the population is slowly growing and has exceeded the pre-war level. At the same time, large banks continue to abuse the non-competitive advantages of high liquidity and are in no hurry to join the fight for depositors’ funds. This limits the impact of rate hikes on the “tying up” of household and business funds in term instruments. In particular, time deposits opened before the outbreak of full-scale war settle in current accounts after maturity, because the term premium in rates is still insufficient given the increased liquidity advantage and wartime precautionary motives. As a result, the share of time hryvnia deposits of the population in the balance of hryvnia deposits of banks will continue to decrease. For its part, a large amount of funds in current accounts in conditions of rather high exchange rate expectations increases the sensitivity of the foreign exchange market to situational factors and creates additional risks for the controllability of exchange rate dynamics. This is evidenced by the growing pressure on the hryvnia exchange rate at the end of 2022 – the beginning of 2023 after the government made significant budget payments. Therefore, further decisive steps by the NBU are necessary to eliminate threats from the structural surplus of liquidity.
The members of the KMP unanimously spoke in favor of the second stage of raising the OR standards, which was announced in December. In particular, they supported raising standards by 5 c. p. for funds on demand and funds on current accounts of legal entities and individuals from February 11.
In addition, an additional increase of 10 c. was supported. p. of the regulations of the OP for funds on demand and funds in the current accounts of individuals in both national and foreign currencies from March 11. However, it was decided not to extend the coverage mechanism of the benchmark OVDP to this part of the reserves.
One of the members of the KMP emphasized that this decision takes into account the need to reduce the liquidity surplus without creating threats to the stability of the internal market of government borrowing. In his opinion, the design of the current decisions regarding OP is designed in such a way that even if part of the liquidity is withdrawn, it will be enough to preserve the ability of banks to actively participate in government auctions for placement of OVDP. Another member of the KMP noted that such an approach to liquidity regulation will make it possible to avoid the resumption of monetization of the budget deficit, which is no less important.
Immediately, several members of the KMP emphasized that the measures taken to “tie up” liquidity may not be enough, because it is steadily fueled by the conversion of foreign currency received from foreign partners to cover high budget costs. For its part, the liquidity attracted by the government through the sale of OVDP returns to the banking system rather quickly. Significant interventions by the NBU only partially absorb liquidity. Therefore, it is necessary to develop additional steps aimed at sterilizing excess liquidity surplus and strengthening monetary transmission.
With this in mind, the panelists discussed the possibility of introducing additional tools to protect the hryvnia funds of businesses and the population from inflation. Various options for optimizing the operational design of monetary policy were also considered, which could, taking into account other NBU measures, contribute to increasing the attractiveness of hryvnia assets. Members of the KMP agreed to continue the discussion on these measures after discussion within the framework of consultations with the IMF and taking into account additional assessments of their potential impact, including on the state of the domestic debt market.
The members of the KMP also agreed that all the measures that the NBU is taking today to stimulate time savings in the hryvnia and maintain the stability of the foreign exchange market should create prerequisites for easing those administrative restrictions on the foreign exchange market that create the most critical distortions in it and have the most negative impact on economic activity.
For reference
Monetary Policy Committee (MoP) is a consultative internal body of the National Bank of Ukraine, created for the purpose of exchanging information and views on the formation and implementation of monetary policy to ensure price stability. The KMP includes: the Chairman of the NBU, members of the NBU Board, directors of the departments of monetary policy and economic analysis, open markets, financial stability, statistics and reporting. Meetings of the KMP take place the day before meetings of the NBU Board on monetary policy. Monetary policy decisions are made by the Board of the NBU.
