Summary of Key Policy Rate Discussion by NBU Monetary Policy Committee on 11 December 2024

Meeting date: 11 December 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
• Oleksandr Arseniuk, Acting Director, Open Market Operations Department
• Yuriy Polovniov, Director, Statistics and Reporting Department.

The MPC members discussed the drivers of the higher-than-expected price growth, its potential impact on economic agents’ expectations, and a combination of monetary policy measures that will bring inflation back to a sustainable deceleration trajectory next year and to the NBU’s 5% target going forward.

Although the H2 2024 uptrend in inflation had been anticipated, the actual rise in consumer prices in recent months has increasingly surpassed the NBU’s forecast (October 2024 Inflation Report), the discussion participants said. In November alone, consumer inflation accelerated to 11.2% yoy, up from the 10% level that the forecast said price growth would not breach before end-2024.

On the one hand, temporary factors continued to be a significant driving force behind the price increase, and the main reason why price developments deviated from the NBU’s forecast. The primary factor was a sharp jump in raw-food prices due to lower harvests this year amid adverse weather. A weakening of the hryvnia’s exchange rate in previous months also had a certain impact. Food inflation is expected to slow significantly in H2 2025 as the effects of this year’s poor harvests wear off. Given that the risk of international financing being inadequate has been subdued, the NBU will retain a strong capacity to smooth out excessive exchange rate fluctuations and ensure sustainable FX market conditions throughout 2025.

On the other hand, underlying price pressures have also been getting markedly more intense. Core inflation picked up to 9.3% yoy in November, driven both by higher prices for processed foods due to costlier raw-food inputs and by a further increase in business costs of energy and labor.

Economic agents’ inflation expectations remained relatively sustainable, surveys showed. However, other signs of concern about rising prices grew more pronounced, like the significantly higher frequency of "inflation" search queries, according to Google Trends data. The uptick in demand for FX cash in October–November amid a certain dampening of appetite for hryvnia deposits could also indicate a deterioration in expectations.

Considering that the war is generating new shocks to the economy, the balance of risks to inflation remains tilted to the upside. A lack of an appropriate response by the NBU in such circumstances may adversely affect confidence in monetary policy and have consequences for the FX market, inflationary processes, and ultimately economic growth.

Seven MPC members supported raising the key policy rate to 13.5% in December

They described such a step as balanced under current conditions, considering the short-lived nature of the main factors behind the current pickup in inflation, as well as the sustainability of inflation expectations. A 0.5 pp hike in the key policy rate at the December meeting, along with steps to maintain FX market sustainability, will be rather sufficient to show the NBU’s willingness to tackle price pressures, a signal that will calm economic agents’ concerns, these MPC members said.

An important prerequisite for the inflationary surge’s temporary nature, which everyone is counting on, is the setting of appropriate monetary conditions, one MPC member said. With inflation significantly above NBU projections, there is every reason for the central bank to stray from the trajectory of October’s key policy rate forecast. Interest rate policy should be strengthened to maintain sufficiently tight monetary conditions, combined with measures to ensure FX market sustainability. This is necessary to slow inflation next year and subsequently return it to its 5% target within an acceptable policy horizon.

Another participant agreed with this MPC member, saying that tightening interest rate policy is an entirely consistent step, given the need to follow through on the forward guidance outlined in the October press release. In it, the NBU clearly articulated its readiness to tighten interest rate policy if price pressures continue to rise above the forecast and threaten to unanchor inflation expectations. In November, price pressures grew more significantly than anticipated, and inflation breached a threshold level that the NBU estimates is about 10% (see the October 2024 Inflation Report for details). This poses the risk of a nonlinear deterioration in economic agents’ inflation expectations.

Another MPC member said the speedup in inflation amid an unchanged key policy rate and a possible worsening of expectations also highlights the issue of hryvnia instruments’ attractiveness as a means of saving money. In particular, the real yield on deposits at some large banks, net of taxes, has declined. This may be one of the reasons why demand for hryvnia term deposits cooled in November. If the NBU does not respond to this in time, then at some point it risks seeing savings flee away from hryvnia instruments and into foreign exchange.

Several participants also said that because the balance of inflation risks is shifted upward and inflation threatens to get stuck in the double digits for a lot longer than projected, their choice was between hiking the key policy rate by 1 pp and nudging it up by 0.5 pp. The 1 pp option was rejected, primarily due to a certain weakening of economic activity in November and a shrinking of the labor shortage, developments that may cool consumer demand somewhat. An additional argument in favor of the more moderate (0.5 pp) tightening of interest rate policy was that the considerably subdued risks of international financing in 2025 being insufficient will support the NBU’s capability to make up for the structural deficit of foreign exchange in the private sector and to smooth out excessive exchange rate fluctuations.

However, the NBU will have to act more decisively going forward if the updated macro forecast in January confirms persistent price pressures and elevated risks of an unanchoring of inflation expectations, these MPC members said.

Two MPC members called for keeping the key policy rate at 13% in December

It is unviable to raise the key policy rate in light of the likely short-term nature of the price surge, the lag in monetary transmission, and the sustainability of inflation expectations, they said. The fading of the effects from this year’s poor harvests should help slow inflation as soon as 2025. Provided the situation in the FX market continues to be sustainable, inflation’s brief stay in double-digit territory in the coming months will not lead to an unanchoring of inflation expectations, they said. The NBU’s capacity to ensure FX market sustainability is beyond doubt, given the high level of international reserves and the announced volumes of external support. Inflation could therefore go back to its trajectory of sustained deceleration without the NBU having to tighten its interest rate policy.

Keeping the key policy rate where it is would be a completely understandable decision for financial market participants, one of these MPC members said. Most financial analysts do not expect the NBU to raise the key policy rate, according to survey data. They are convinced the spike in inflation is temporary. Evidence of this includes the fact that financial analysts have upgraded their inflation forecasts for December 2024 (to 10.5% yoy from 9.1% yoy) while simultaneously downgrading their inflation expectations for end-2025 (to 7.2% yoy from 7.4% yoy). This means there is no urgent need to send reassuring signals through the expectations channel, this participant said. On the contrary, a significant rate rise without updating the macro forecast will be perceived as an emergency hike, potentially resulting in heightened uncertainty and causing market participants’ expectations to deteriorate. However, a symbolic increase in the key policy rate will seem unconvincing.

Another MPC member agreed with these statements, saying that the major drivers of the current price surge are largely non-monetary and not very sensitive to interest rate policy impulses. Furthermore, because of the transmission lag, the effects of the December rate rise will fully play out only when the inflationary surge itself begins to subside. But at this time, households retain their interest in hryvnia savings, despite a certain decline in the real yield on hryvnia instruments. This may be because current rates on domestic government debt securities and hryvnia deposits still exceed the rate of inflation expected for the next 12 months, this MPC member said. The NBU is therefore successfully fulfilling its task of ensuring that hryvnia savings are protected from inflation. To shore up demand for hryvnia instruments, the NBU needs to continue to ensure a sustainable situation in the FX market.

Two MPC members suggested raising the key policy rate to 14% in December

They said the NBU should act urgently and decisively, as inflation has been, for several straight months, not only surpassing the NBU’s forecast, but also rising rather fast, increasingly showing signs of persistence and threatening to go into an inflationary spiral (whereby expectations fuel wage growth, which in turn pushes prices even higher).

The discussion about the "non-monetary" nature of inflation drivers is purely theoretical, but may actually prove harmful in practice by delaying an optimal response, these MPC members said. Global experience shows that a central bank should place its focus not so much on the initial origin of a price surge as on its anticipated persistence. 

The MPC members cited several signals in this regard. First, several indicators are pointing to a dangerous increase in underlying price pressures. Certain significant pro-inflationary factors, such as the tight labor market, are being quite persistent. Price increases above the inflation target (5% yoy) have already affected more than 60% of the consumer basket. Annualized seasonally adjusted core inflation has been consistently above 10% yoy in recent months.

Second, inflation has already breached the threshold level of attention. Concerns over the cost of goods and services are likely to continue to grow, which will have a proportional impact on economic agents’ expectations and financial decisions. Third, the balance of risks to inflation remains considerably shifted upwards, including due to a possible rise in administrative tariffs and significant budget expenditures, especially on social security benefits.

Inflation is significantly likely to stay in the double digits for longer than currently anticipated, these MPC members said.  Regardless of the initial nature of the price surge, it will substantially blunt the appetite for hryvnia instruments and erode the credibility of the NBU’s monetary policy. To regain control over expectations and inflation developments, the NBU will still have to hike the key policy rate, but much more radically than if it were increased now in a precautionary move.

To avoid delaying important decisions, the NBU should not become hostage to financial market participants’ expectations about the invariability of the key policy rate, one of these participants said. For six months running, analysts have been underestimating by an average of 0.7 pp the pace of inflation acceleration. This is probably in part a result of anchoring to the NBU’s previous forecasts and in part a consequence of the expert community’s collective underestimation of the price surge’s persistence. There is a risk that repeated inflationary "surprises" may lead to a significant overestimation of inflation expectations and to criticism that the NBU is being short-sighted. We should therefore avoid taking the current sustainability of inflation expectations for granted. Instead, it makes sense to account for risks and proceed proactively. 

Inflation’s deviation from the forecast has been observed for several months now, and what is more, this deviation is expanding, another participant said. Inflation could, in December already, exceed a peak that the forecast said would be reached no sooner than April 2025. Under such conditions, the absence or weakness of a response to obvious inflationary challenges may call into question the NBU’s declared intentions to return inflation to a sustainable deceleration trajectory towards the NBU’s 5% target within an acceptable timeframe and to ensure proper protection of hryvnia savings from inflation. To prevent this from happening, we need to actively strengthen interest rate policy now. Moreover, the NBU has also declared an intention to gradually restore the key policy rate’s role as the main instrument of monetary policy and has made considerable efforts to reinforce its effectiveness.                                                            

Most MPC members said they expect further key policy rate hikes in the coming months

The tightening cycle of interest rate policy needs to be continued in the months ahead if inflationary pressures and the risk of an unanchoring of inflation expectations do not ease off, most MPC members said. The NBU will have to hike the key policy rate several more times in January–April 2025, two of these MPC members said. And a need to strengthen the incentives in the operational design of monetary policy cannot be ruled out, they said. The NBU should press forward with its active efforts to smooth out excessive exchange rate fluctuations in the FX market, they said.

However, several MPC members were unsure about the need to raise the key policy rate at upcoming meetings. At the time of the meeting, they were convinced of the inflationary surge’s temporary nature, in particular because the effects from low crop yields were expected to fade. Keeping monetary conditions where they are now will be sufficient to relieve price pressures next year, these MPC members said. However, a January update to the macro forecast will provide more data on inflationary pressures’ persistence.

If price pressures weaken in H2 2025 as expected, the NBU could return to a cautious easing of interest rate policy, almost all MPC members agreed. However, their estimates regarding the possible level of the key policy rate at end-2025 ranged between 11% and 14%, a significantly wide spread. Given the current economic uncertainty, several MPC members refrained from assessing the long-term level of the key policy rate until the update is made to the January macro forecast.