ICU Weekly Insight: Inflation Accelerates Above Central Bank Expectations

Bonds: Net domestic borrowings reached UAH236bn in 2024

Last year, Ukraine’s Ministry of Finance (MoF) refinanced all FX-denominated redemptions while borrowing in hryvnia significantly more than it repaid. This year’s budget envisages tiny net borrowings.

The MoF borrowed UAH617bn from the domestic bond market in 2024, including UAH139bn in hard currency (US$2.7bn and EUR0.75bn), while repaying UAH382bn, including UAH134bn in foreign currency (US$2.4bn and EUR0.9bn).

The total refinancing ratio was 162%, including 193% for hryvnia instruments, and 104% for hard currency.

For the full year, net borrowings stood at UAH236bn or UAH122bn less than budgeted.

This year, the MoF has to redeem about UAH490bn worth of domestic bonds, including UAH325bn, US$2.9bn, and EUR0.75bn.

The months with the largest redemptions will be October (UAH61bn), March (about UAH52bn), and April (about UAH53bn). The largest one-day redemption of UAH41bn is scheduled for February. The budget law for 2025 assumes only UAH17bn of net domestic borrowings.

ICU view: For this year the MoF’s current task is simply to refinance all scheduled redemptions.

However, in previous years, the authorities revised the plan for domestic borrowings in the second half of the year to match them with an increase in budget expenditures.

Therefore, it’s very likely the government may increase the borrowing plan either in 3Q25 or in 4Q25. Debut auctions (see comment below) show that banks’ interest in military bills fell compared with November or December 2024.

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Ukraine’s Sugar Exports to EU Almost Halve Despite Record Production

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Banks’ demand was concentrated primarily in the new four-year paper, which the NBU can add to the list of bonds that are allowed to cover mandatory reserves.

Bonds: Demand for military bills low

Last week, the MoF borrowed just UAH6bn, mainly from a new four-year paper.

At the debut primary auction this year, the MoF offered three military bills that it started to issue last month, and a new four-year note, which can become new reserve paper. Demand for military securities was low, at just UAH650m.

At the same time, the new four-year paper saw almost a 10x oversubscription. The MoF sold UAH5bn of new bonds, set the cut-off rate at 16%, 100bp above the yield for a 3.5-year paper at the beginning of last month.

The weighted average rate was set at 15.99%, or 140bp above interest rates for 3.5-year paper place at the end of the last year. 

Individuals maintained high interest in bonds and increased their portfolios to above UAH80bn last week.

ICU view: Banks’ interest in military bills was substantially down YTD following massive purchases of such bonds last autumn. Therefore, demand for military bonds will mainly originate from the retail segment.

However, banks will maintain their high demand for four-year notes that are likely to become designated reserve bonds. The MoF may attempt to lower the yield on such bonds going forward.

Bonds: Eurobond rally fades

Prices of Ukrainian Eurobonds declined last week due to a growing realization that a quick end to the war is very unlikely.

Eurobond prices reached a peak in the first few days of the year. UKRAIN’A‘29 price was above 70, and UKRAIN’B‘35 and UKRAIN’B‘36 prices reached 60.

Yet, last week, prices declined by an average of 2.5% and spreads to the benchmark widened by 9-94bp. The EMBI index slid by 0.8% last week. VRIs’ price rose last week by 0.6% to 80.5 cents per dollar of notional value.

ICU view: Investors probably started to realise that their expectations were overly optimistic. The special envoy of the US President-elect to Ukraine said it could probably take up to 100 days to reach a cease-fire agreement.

On the other hand, this message may signal that the new administration will not force Ukraine to make quick and inappropriate concessions to russia. This week, the market will operate in anticipation of the inauguration of the new US president and his first messages in an official role.

FX: NBU does not allow hryvnia to weaken significantly

The FX market remains under demand pressure in the first weeks of the year. The NBU has had to spend a considerable amount of reserves to control the FX market.

Last year, the NBU sold US$34.8bn from international reserves, while weakening the hryvnia by 10.6%. In December, the NBU sold US$5.3bn, a record volume of monthly interventions since the full-scale war.

This year, demand for hard currency declined slightly, and the NBU sold US$1.4bn YTD, including US$1.04bn last week, while allowing the hryvnia to weaken by less than 0.6% to UAH42.28/US$ last week.

Net hard currency purchases in the market amounted to US$1.2bn YTD, including US$678m in the interbank market and US$560m in retail segment.

Average net daily purchases in the interbank FX market fell from US$160m in December to US$97m YTD, while households increased net daily purchases from US$59m last month to US$80m YTD.

ICU view: Total demand for hard currency in the FX market declined compared with December, but stayed above last year’s average. Similar elevated demand was seen at the beginning of last year, too, but the situation changed at the end of January, and the hryvnia appreciated slightly.

We anticipate that the NBU will allow the hryvnia to fluctuate around the current level in January. Exchange-rate stabilisation will encourage more FX supply from exporters and may reduce the need for NBU interventions.

We expect the NBU will not allow the hryvnia to weaken above UAH42.5/US$ this month and will move the exchange rate to about UAH46/US$ by year’s end.

NBU reserves up 8% in 2024

Gross international reserves of the NBU were up 9.7% in December and up 8.1% in 2024 to US$43.8bn, a new all-time high.The inflow of foreign financial aid hit a record high in December 2024 at US$9.5bn, which helped boost gross international reserves of the NBU.

The largest facilities included US$4.4bn in financial aid from the EU, US$4.0bn from the US, and US$1.1bn from the IMF. Meanwhile, the need for sale interventions in the FX market was also at a record high level of US$5.3bn. Payments to official lenders by the NBU and the government totaled about US$0.4bn in December 2024.

ICU view: Despite record high inflow of foreign financial aid in December, the NBU end-2024 international reserves landed somewhat below our estimate of US$44.1 due to the abnormally high need for NBU sale interventions in the FX market.

Given the commitment of Ukraine’s international partners to provide nearly US$39bn in financial aid in 2025, we expect NBU reserves to remain broadly stable in the range of US$40-45bn over the year. This implies the NBU will have sufficient resources to keep the FX market relatively balanced.

Yet, the focus of the market attention is now shifting on the prospects for financial aid in 2026. If expectations materialize that foreign financial aid to Ukraine will decline significantly in 2026, this may create significant pressures on the NBU reserves in 2H25.

Inflation remains above expectations in December

Consumer inflation accelerated further to 12.0% in December, up from 11.2% in November, beating most expectations.Monthly inflation stood at 1.4%, down from 1.9% in November. Annual core inflation accelerated to 10.7% from 9.3% in November.

Inflation remains driven by food prices, which were up 14.2% YoY in December. Several consumer-basket components saw a significant acceleration in annual prices. Growth in prices for transportation reached 7.1% vs. 4.7% in November, as low base effects played out (gas prices fell substantially in December 2023).

Communication tariffs were up 9.1% YoY vs. 4.7% YoY in November as several mobile operators hiked tariffs to cover higher operating costs. Prices for most other components of the consumer basket also accelerated marginally.

ICU view: Inflation exceeded market expectations in 2H24 mainly due to adverse effects of the poor agricultural harvest.

In terms of foods prices, an important observation is that their annual growth decelerated somewhat in December for the first time since prices started to pick up since early last summer.

This may signal that the impact of the poor harvest on consumer prices is starting to ease, but it’s too early to make a definite conclusion. Inflationary pressures will remain elevated in 1H25, and we may see a moderate pick up in annual inflation in 1Q and 2Q.

Yet, we expect the inflation will start to decelerate sharply from June 2025, as new harvest is supplied to the market, and food prices normalize following last year’s hike. The annual CPI will decelerate to 7.0% per our projection.

We expect another 50bp increase in the NBU key policy rate in January to 14.0%, but further steps will largely depend on CPI prints for January and February. There is a good chance that the NBU will not lift the key rate above 14.0%.