Five members of the Monetary Policy Committee (MPC) suggested cutting the key policy rate of the National Bank of Ukraine (NBU) from 25% to 22% at the end of July, three MPC members spoke in favor of a more significant reduction in the key policy rate in July: two of them said it should be slashed to 20%, one suggested a cut to 21%, and three MPC members advocated a more moderate decrease in the key policy rate in July: two of them suggested cutting it to 23%, one to 22.5%.

"The wide gap between actual inflation and the key policy rate allows room for a more substantial first step than previously anticipated," the National Bank said, giving this opinion of the five MPC members on Monday in the results of the committee discussion held on July 26 and reported that the majority of market participants, according to polls, expected a rate cut to 23%.

According to the five members, a rate cut of 3 percentage points (pp) will not only meet the general expectations of the market and consumers, but will also send a positive signal of greater willingness to support the economic recovery. At the same time, slower inflation and better expectations will make it possible to keep hryvnia assets attractive enough even as a nominal reduction of the key policy rate occurs.

Among other arguments, the macroeconomic situation has continued to improve at a faster pace than projected, such a decrease is a logical response to the significant positive revision of the macroeconomic forecast in a positive direction.

According to these MPC members, many banks still have deposit rates well below the key policy rate, indicating that there is sufficient headroom for interest margins, and that sufficient competition for depositors among small and medium-sized banks will keep market rates lower.

"The official exchange rate currently remains fixed. The closest to it is the cash rate, which is the primary anchor for households’ expectations. Under such conditions, with the risk of depreciation being insignificant, hryvnia assets will remain sufficiently attractive even after the key policy rate is reduced by 3 pp," one of the participants in the discussion gave another argument.

As for their more radical colleagues, in their opinion, the faster-than-expected improvement in the macroeconomic situation creates opportunities for the NBU to support the economic recovery by easing its interest-rate policy more quickly than previously discussed. The NBU's actions up until now have been cautious, and its macroeconomic forecasts are based on rather conservative assumptions.

"Businesses and households have fully adapted to operating under new conditions. The course of the war is no longer having as significant an impact as it used to have on their behavior and decisions," one of the MPC members said, giving such an argument in favor of more active actions of the National Bank. Specifically, this MPC member is expecting significant capital inflows in the years ahead and is therefore seeing no threats to the sustainability of the FX market. An investment boom driven by both international injections and a return of the capital withdrawn from Ukraine will stimulate the economy without significantly ramping up inflationary pressure.

During the discussion, its participants said that bankers and analysts expected the NBU to reduce the rate by 2 pp, but considered it appropriate to lower it more.

"The market is beginning to recognize that the regulator is moving slowly. Accordingly, not only will a more decisive reduction in the rate come as no surprise, but also it will reinforce confidence in the NBU's policy," the regulator said in the report.

As for the three more cautious MPC members, they warned against premature euphoria and a more aggressive easing of the interest rate policy.

"Under the current monetary regime, the key policy rate should be aimed primarily at maintaining exchange rate sustainability and that the current inflation rate is not a definitive benchmark for estimating the level of the key policy rate," they said.

They also pointed out that it may be rather difficult to slow inflation further and implement the Currency Easing Strategy. Specifically, they said, there is considerable uncertainty over the duration and intensity of the war, the risk of the grain corridor’s termination has materialized, and the possibility that individual EU countries may extend their trade restrictions on Ukraine's agricultural products is still there.

"With uncertainty running high and new economic challenges emerging, previous gains can be lost very quickly, and the consequences of a policy reversal can be extremely dangerous," they said.

In addition, supporters of a smaller rate cut expressed concern that the reduction in the key policy rate and the revision of the forecast for its dynamics should be moderate in order to prevent a rapid decline in deposit rates, as banks traditionally cut deposit rates faster than they raise them. This asymmetry may currently intensify, in part due to the record surplus of liquidity, the high concentration of the retail deposit market, and the sharp drop in inflation, they added.

As reported, from July 28, the NBU decided to lower the key policy rate to 22% from the level of 25% at which it had kept it since June 6, 2022.

In addition, the National Bank revised the forecast schedule of the key policy rate, and according to its updated version, it most likely expects it to decrease to 18% from the beginning of 2024 and to 16% from the beginning of 2025.