NBU raises key policy rate to 25%

The Board of the National Bank of Ukraine has decided to raise the key policy rate to 25% per annum. Along with other measures, this resolute step aims to protect households’ income and savings in the hryvnia, raise the attractiveness of hryvnia assets, reduce the pressure on the foreign exchange market, and thus enhance the NBU’s capability to maintain the stability of the exchange rate and restrain inflation processes during the war.

The need to change monetary policy is caused by the economy’s need to adapt to the war. As the economy begins to adapt to life in war conditions, macroeconomics must be based on new realities. There are several risks that indicate the need for change, in particular, the formation of monetary overhang in the form of divergence of trends in current and time deposits, changes in the structure of the current account with regard to the balance of payments and the growing role of foreign exchange reserves. Although Ukraine’s international reserves are still sufficient thanks to funding from international partners, risks to macrofinancial stability have risen in the medium term. If yields on hryvnia assets do not rise sufficiently, international reserves will keep depleting rapidly and imbalances will build up in the economy.

In April, inflation accelerated to 16.4% yoy. In particular, core inflation rose to 13%. In monthly terms, prices grew by 3.1%. According to the NBU’s preliminary estimates, inflation continued to accelerate in annual terms in May. The main factors accelerating inflation were disruption of supply chains, increased business costs and physical destruction of enterprise assets due to the full-scale war. Global inflation is also at a record-high. In particular, the inflation rate in the United States and euro area countries is over 8%. This factor is also pushing up domestic prices.
The NBU has also decided to widen the interest corridor for monetary transactions with banks to provide additional room for reviving the interbank market. More specifically, from 3 June, the interest rate on refinancing loans will equal the key policy rate plus 2 pp, while that on certificates of deposit will be the key policy rate less 2 pp. The NBU expects that the government and the banks will respond adequately to the hike in the key policy rate by raising interest rates on domestic government debt securities and deposits. An appropriate response of market interest rates to the key policy rate hike will make hryvnia assets, including domestic government debt securities, more attractive, preventing household income and savings from being eroded by inflation.

After considering several scenarios, the NBU decided to raise the key policy rate by a whole of 15 pp, to 25% per per annum. The NBU believes that a slight increase in the key policy rate would have had no significant influence on the financial and economic system. The first reason for this is that the monetary transmission mechanism has only a limited effect in wartime. Second, this would have resulted in expectations of further increases in the key policy rate and, consequently, depositors taking a wait-and-see approach and, investors having weak interest in hryvnia assets. Third, to revive interest in hryvnia assets, their yields must exceed expected inflation rates.