Ukraine: Central Bank changes monetary policy framework amid deteriorating economic situation
February 6, 2015
At its 5 February monetary policy meeting, the National Bank of Ukraine (NBU) decided to modify its monetary policy framework as the Bank moves toward an inflation-targeting regime. The Bank announced two key changes to the existing framework. First, that interest rates on liquidity adjustment instruments will be aligned with the discount rate, strengthening the discount rate’s role as the benchmark monetary policy rate. Second, the Bank announced that it would no longer hold foreign exchange auctions nor set the indicative hryvnia exchange rate, allowing the currency to float more freely. In addition, the Bank decided to raise the discount rate by 5.5 percentage points from 14.00% to 19.50%. The discount rate is now at the highest level since May 2001. The Bank’s announcements come amidst a deteriorating economic situation for Ukraine and increasing pressure for the country to secure additional funds from the IMF.
In its accompanying statement, the Central Bank commented that Ukraine faces strong inflation risks which prompted the Bank to change its monetary policy framework. The Bank stated that annual inflation reached 24.9% in December 2014, driven by, “the depreciation of the hryvnia exchange rate as a result of imbalances built up over the past years and worsened expectations amid the social and political turmoil and the military conflict in the east of Ukraine.” Moreover, the Bank believes that inflationary pressures will persist as a result of the conflict in the east of the country.
Looking forward, the Bank stated that the more rigid monetary policy along with additional measures taken by the Ukrainian government could contain inflationary pressures as soon as the first half of 2015 and bring inflation below 10% in 2016. The Bank expects that an increase in the discount rate will not have a large impact on the real sector as, “bank lending activity remains considerably subdued amid heightened risks in the business environment.” Moreover, the Bank stated that higherinterest rates may foster the return of household deposits to Ukraine’s banks and decrease inflationary pressure.