Seven NBU monetary policy committee members backed rate hike to 25%, another 2 suggested 24%

MOSCOW. June 14 (Interfax) - The National Bank of Ukraine's (NBU) decision to hike its key interest rate from 10% to 25% was supported by seven of the monetary policy committee's ten members at its meeting on June 1, with two committee members in favor of a 24% rate, and one suggesting 20%, the NBU said in a statement on its website on Monday.

"During the debate, the members of the monetary policy committee came to a conclusion that maintaining the stability of the exchange rate in today's conditions is a guarantee of price and financial stability. The stability of the exchange rate remains the uncontested nominal anchor for expectations, a mechanism for subsidizing critical imports and, consequently, the main tool for reining in inflationary pressure and for supporting the sustainability of the financial system," Ukrainian media outlets quoted the NBU as saying in its press release.

The economy is not yet ready to return to the floating exchange rate, it said.

For this to happen, macroeconomic prerequisites should be put in place first, including the forex market's increased ability to regulate itself. Otherwise, any adjustments of the official exchange rate will only serve to cause additional shock for economic agents, to dampen expectations and cause prices in the country to rise by a certain number of percentage points, but pressure on the hryvnia and the international reserves will persist.

In today's conditions, the NBU needs to revive a proactive interest rate policy and to make hryvnia-denominated assets attractive again as investment and savings tools, the NBU said.

Among potential adverse effects of the interest rate surge, the monetary policy committee's members listed the largest cost of servicing state debt due to a growth of the yield rate on government bonds and the spending on servicing the state's loan support programs.

"Nevertheless, this effect on budget expenditure in 2022 is assessed as insignificant (main burden expected in 2023) and may be neutralized by borrowing extensively on the market," the NBU said.

The participants in the meeting also discussed the impact of the interest rate hike on banks' balances due to the potential possibility to re-assess securities in banks' portfolios, the increase in interest payments on refinanced loans and banks' proceeds from deposit certificates.

"The effect of securities re-assessment will be extended over time, while the structural surplus of the banking system's liquidity is more likely to allow banks to benefit from the interest rate increase than the opposite. The impact of the interest rate hike on loans will be limited in today's conditions," the NBU said.

The NBU believes that the cost of loans depends above all on the actual cost of banks' funding, which is still very low today and will not change rapidly due to the low cost of previously attracted deposits.

Second, the majority of new loans are currently being issued under state programs, and, consequently, preferential terms will remain in force for such borrowers in the future, it said.

The participants in the debate also agreed that in order to noticeably reinvigorate interest in hryvnia-denominated assets, the interest rates on them should be increased to a level above economic agents' inflationary expectations in the mid-term prospect, i.e. to 24%-25%.

"This will create the motivation for depositors and investors to report high yield on hryvnia-denominated instruments until the NBU shifts into a rate reduction cycle. A minor rise of the interest rate is unlikely to change the situation. Market players will expect the rate to grow further and will mostly postpone decisions on investments and savings until they decide that hryvnia-denominated instruments' yield has reached its maximum," the NBU said.

As reported, the NBU's decision to hike its key rate from 10% to 25% has come as a surprise both to the market and the Finance Ministry, which so far refrains from raising the rates on government bonds at market auctions following the key interest rate surge. The annual interest rates on government bonds currently remain within a 9.5%-11.5% range.