The NBU is working to "curb inflation." What impact will this have on the exchange rate?

The last six months have been challenging for the National Bank. The institution, whose main task is to maintain price stability in the country, has faced a sharp rise in inflation that exceeds its own forecasts month after month.

The increase in prices continued into 2025. In January, they rose by 12.9% compared to the first month of 2024. Moreover, the current rate of depreciation of the national currency has already surpassed the average interest rates that banks offer on hryvnia deposits.

To combat rising prices, the NBU resorted to a rapid increase in the discount rate, hoping that this would lead to higher yields on deposits and government bonds (OVGZ). However, the regulator has another "trump card" - the dollar exchange rate.

During December and January, the National Bank "burned" its foreign currency reserves at a record pace, causing concern among some citizens. Will these actions help curb price increases, and what can we expect from the dollar exchange rate in the near future?

"Fire Sale" of Reserves

In the last month of 2024, the NBU set a new record: the volume of currency sold from reserves reached 5.28 billion dollars. The National Bank had not "burned" so much currency even in the middle of 2022, when there was a frenzy of demand for foreign currency in the market, and the difference between the NBU's official rate and the rates at exchange offices exceeded 10%.

High volumes of currency sales from reserves continued into January 2025: the National Bank had to sell 3.75 billion dollars. Consequently, over the two-month period, the regulator "burned" more than 9 billion dollars to cover excessive market demand.

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Despite these alarming figures, there is no panic in the currency market, and the volume of foreign currency reserves remains around a record high of 43 billion dollars, thanks to international aid inflows.

The record volumes of dollar sales from reserves were influenced by market factors. Firstly, at the end of 2024 and the beginning of 2025, the dollar strengthened globally due to expectations formed by Donald Trump's victory in the U.S. presidential elections.

Secondly, economic factors contributed to additional demand. "The import of goods reached a three-year high, and the negative balance of goods and services hit a historical record," says the chief expert on macroeconomic analysis at Raiffeisen Bank, Sergey Kolodiy.

Thirdly, government agencies traditionally tried to spend all unutilized funds allocated in the budget during the last weeks of the year. In 2024, the scale of these expenditures reached unprecedented levels - over 704 billion hryvnias in one month. "This is a record in history," stated Yaroslav Zheleznyak, deputy chairman of the tax committee of the Verkhovna Rada.

Part of the hryvnias spent from the budget ended up in the currency market, leading to increased demand for foreign currency. In such conditions, the National Bank was forced to devalue the official hryvnia exchange rate, as required by the chosen regime of "managed exchange rate flexibility." By mid-January 2025, the official dollar rate reached a new historical maximum of 42.28 hryvnias.

This devaluation of the hryvnia proved to be as untimely as ever, as inflation continues to rise in Ukraine alongside the dollar's exchange rate. The depreciation of the national currency only exacerbates this process, as a more expensive dollar automatically means higher prices for all imported goods - from food to fuel.

Inflation Exceeds Deposit Yields

Inflation in Ukraine began to rise in mid-2024. Initially, this process seemed manageable and predictable. However, due to a hot, dry summer and electricity shortages resulting from Russian shelling, the pace of price growth turned out to be much higher than expected by economists and the National Bank.

In October and January, the NBU updated its macroeconomic forecasts and worsened its inflation expectations. However, the pace of price growth stubbornly exceeded even the revised forecasts, forcing the regulator to take stringent measures.

In December, the National Bank reversed its monetary policy and increased the discount rate from 13% to 13.5%. In January, the key interest rate was raised to 14.5%.

With these actions, the regulator aims to raise the interest rates on hryvnia assets - primarily deposits and OVGZ.

However, it seems that the NBU has not yet achieved the desired results. In January, annual inflation reached 12.9%, again exceeding forecasts. Moreover, it crossed the dangerous threshold, surpassing the nominal deposit interest rates - averaging 12.52% (annual deposit in hryvnias at major banks). After accounting for increased taxes, the real yield is even lower - 9.64%.

Although comparing these indicators is not entirely accurate, since inflation reflects how much prices have increased over the past 12 months, while the deposit rate indicates how much the bank will pay in the next 12 months. Nevertheless, such a level of rates does not instill confidence in citizens regarding their hryvnia savings.

Maintaining the attractiveness of the hryvnia is the foundation of the NBU's monetary policy during this major war. If citizens do not feel that deposits and OVGZ protect their savings from inflation, they will begin to increasingly stash their funds in foreign currency. Consequently, demand for it will rise, international reserves will start to rapidly deplete, and the exchange rate will soar.

The NBU aims to prevent such a scenario using all available methods.

"A Trump Card"

From mid-January to mid-February, the dollar exchange rate in Ukraine unexpectedly decreased by 60-80 kopecks. The strengthening of the hryvnia was influenced by businesses paying taxes and salaries (some entrepreneurs sold foreign currency reserves for this), the activation of exporters, and an overall decrease in demand for foreign currency. Another factor likely at play was the regulator's desire to curb prices.

"The imbalance between supply and demand in the market persists and is covered by the National Bank's daily interventions to sell foreign currency, so the current strengthening of the exchange rate is primarily due to the regulator's efforts," notes Yuri Krokhmal, head of the treasury products sales department at Avantgarde Bank.

The NBU is not new to using the exchange rate as a tool. Since October 2023, when Ukraine abandoned the fixed exchange rate for the dollar, a clear correlation between it and the inflation level has emerged.

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"The NBU has demonstrated that it is willing to allow only those fluctuations in the exchange rate that do not threaten to bring inflation to its target of 5%. For instance, the central bank allowed for a weakening of the hryvnia when inflation deviated downward from the target. And it significantly narrowed exchange rate fluctuations when inflation began to deviate upward," notes former NBU Council member Viktor Kozyuk.

The main goal declared by the NBU is to maintain moderate inflation at 4-6% per year. It is no surprise that it uses its exchange rate policy to curb price growth. "By restraining the hryvnia's depreciation, the NBU thus curbs the rise in prices for imported goods and raw materials, 'anchoring' devaluation expectations, which in turn positively impacts the attractiveness of hryvnia assets," believes Dmitry Taranenko, junior economist at Dragon Capital (owner