Key policy rate, a strong hryvnia, and price optimism: What decisions did the National Bank of Ukraine make on June 15th?

The latest meeting of the National Bank's Board, which took place on June 15th, didn't bring any significant revelations. The NBU, as usual, kept the key policy rate at 25% (for the eighth time this year) and provided quite optimistic forecasts regarding inflation rates until the end of 2023. Additionally, the National Bank announced currency easing.

However, the NBU added a spoonful of tar and reminded that the prolongation of hostilities, as before, poses significant risks to Ukraine's economic potential and unpredictable inflation shocks. This, in turn, threatens exchange rate stability and creates a risk of an inflationary spiral. The regulator's main decisions and prospects were examined by Mind.

Key policy rate. Nothing has changed here – the key policy rate will remain at 25% for the next one and a half months (the next meeting of the NBU Board devoted to monetary policy issues is scheduled for July 26th).

At the same time, the National Bank does not exclude the possibility of starting to lower the key policy rate earlier than planned. However, it will only happen if the growth in real profitability of hryvnia instruments continues and there are no threats to the exchange rate of the hryvnia. The NBU's macroeconomic forecast in April stated that the rate reduction should begin in the fourth quarter of 2023.

The situation in the currency market. The NBU briefly addressed the issue of the exchange rate. Andriy Pyshny merely stated the fact of systematical strengthening of the hryvnia and reminded that this is facilitated, in particular, by the existing model of the National Bank's monetary policy, which allows for maintaining a high level of profitability of hryvnia instruments.

Indeed, the exchange rate has significantly strengthened. Over the course of three months, from mid-March to mid-June, revaluation amounted to nearly 4%. Moreover, since around the 20th of May, the national currency's exchange rate has remained in a narrow range of 37–37.5 UAH/USD, and there are currently no signs of hryvnia weakening.

Changes in the UAH/USD cash exchange rate

Source: finance.ua data

However, the profitability of hryvnia instruments, as mentioned by the governor of the NBU, is not impressive. For example, interest rates on hryvnia deposits seem to have reached their peak. At least from April 7, when NBU updated the design of its monetary policy, until June 15, the profitability of hryvnia deposits with a term of 6–12 months increased on average by 0.9–1.4 percentage points, reaching 13.7–15% per annum (according to the UIRD index).

As of May 1, the share of term bank deposits held by the population remained at approximately 38%, the same as on April 1. Perhaps it is too early to draw conclusions, and in June, the movement of funds from current accounts to deposits will become more noticeable. For example, the governor stated that the increase in the share of term deposits in the national currency has indeed resumed.

The central bank has also noted an increased interest of the population in domestic government bonds in recent months. The portfolio of domestic government bonds held by individuals has indeed grown by approximately 37% since the beginning of 2023, reaching around 41.6 billion UAH. However, the overall volume of issued bonds held by the population is extremely small, accounting for only about 3%. On the other hand, large holders of domestic government bonds, such as banks, are not rushing to buy them: the banking portfolio of bonds has increased by 12% since the beginning of the year, reaching 544 billion UAH.

Source: NBU data

However, NBU believes that the profitability of deposits and domestic government bonds has not reached its limit. Moreover, the confidence of the NBU is so strong that the regulator has even considered lifting certain foreign exchange restrictions.

Currency relaxations. National Bank, as of 16th June, has permitted resident borrowers to transfer funds abroad to fulfil obligations related to external credits and loans that are:

• secured by a guarantee or the endorsement of an international financial organisation;
• provided with the involvement of a foreign export credit agency or a foreign state through its authorised institution.

The National Bank of Ukraine (NBU) has specified that residents will be able to carry out such transactions according to the terms of repayment and interest payments outlined in the loan agreement. This precautionary measure will help mitigate capital outflows, protect international reserves, and maintain currency market stability.

Inflation as a factor influencing the monetary policy of the NBU. The National Bank of Ukraine did not overlook the situation with inflation. Andriy Pyshny stated that the pace of consumer price growth is slowing down faster than expected. In May, inflation stood at 15.3% on an annual basis.

As noted by the NBU, apart from the base effect, this was facilitated by sufficient food and fuel supply, strengthening of the cash exchange rate of the hryvnia, and improvement in inflationary and exchange rate expectations. And of course, Pyshny reiterated that the monetary policy of the NBU plays a significant role in these processes. Thus, according to the NBU's forecast, announced at the end of April, inflation is expected to slow down to 14.8% in 2023.

However, fundamental inflationary pressure remains quite high. Moreover, reserves for further inflation reduction are gradually depleting. Despite the levelling off of logistics in Ukraine and price reductions in the global markets, negative effects will be caused by increases in certain tariffs for housing and communal services (electricity), the future return to pre-war taxation levels in the fuel market, and the damage to the Kakhovka Hydroplant, leading to partial crop losses in the southern regions of the country.

Inflation in Ukraine in January – May 2023

Source: State Statistics of Ukraine data

What steps to expect from the National Bank in the coming months? Based on the decisions made by the NBU's board and statements from its leadership, the following conclusions can be drawn:

1. the key policy rate remains unchanged. And it is likely that the rate will not be lowered until autumn, when the period of summer economic decline has passed and the situation with exports of the new harvest is clear;
2. the National Bank is ready to lift currency restrictions. However, it will do so cautiously to avoid harming the hryvnia and the economy as a whole;
3. there is currently no discussion of transitioning to a floating exchange rate. While the NBU does not dismiss such plans, it is clearly not in the immediate future;
4. the focus on increasing the profitability of hryvnia assets remains. However, banks are not rushing to raise deposit rates. Therefore, the National Bank may resort to new restrictions on banks' placement of free liquidity in certificates of deposit;
5. combat operations remain the main risk for both the foreign exchange market and the inflationary situation. Therefore, the actions of the National Bank will undoubtedly be adjusted based on the situation on the front.