The bank has been under pressure to revalue or liberalise the hryvnia after inflation began rising last year, hitting 30 percent annually. Ratings agency Standard & Poor's immediately called the bank's move a step towards curbing price rises.
"Liberalising the exchange rate regime should help to curb inflation of tradeables, and in particular commodities such as gas and food, which are priced in dollars," the agency said in a statement. It has a rating of BB- for Ukraine.
"It is more or less what the market has been trading the past few days. It's a first step," BNP Paribas currency strategist Elisabeth Gruie said.
"It's clearly not going to be enough. I would say they would need another five to 10 percent to tackle inflation," she said.
The bank had kept the hryvnia in a tight range of 5.00-5.06 since 2005, within a wider target of 4.95-5.25 but traders said it stopped intervening in February-March.
The hryvnia had been hovering around 4.7-4.8 since then, but soared further in recent days to 4.6 to the dollar after comments from various central bank officials indicating a revaluation soon. On Wednesday, the hryvnia traded at 4.54/$.
The bank had said that a news conference was due on Thursday at 1400 GMT after a meeting of the policy council.
Dealers in Kiev have been critical of the lack of clarity from the bank since it appeared at odds in April when Chairman Volodymyr Stelmakh said "a move" would be made on the hryvnia, only for the bank's council to reject widening the band.
One dealer said despite expectations that the bank would make a decision soon, it was still unclear whether the currency band would be kept or whether the bank would allow the hryvnia to float freely.
"If this is going to be a floating rate, I don't see any reasons why (the dollar) won't continue to drop, if the bank refrains from entering the market," the dealer said.
"They must begin market interventions, otherwise neither clients nor banks will have any targets (of where the rate should be)," he said, mentioning the example or Russia who's central bank said last week it would begin daily interventions.
Markets had been betting on neighbouring Russia revaluing the rouble against its dollar/euro basket to rein in its inflation running at over 14 percent annually.
But its move last week has made the market more volatile and making it more difficult for dealers to guess the regulator's policies.
In its comments after the bank's move, Standard & Poor's painted a bleak picture for Ukraine, saying inflation was boosted by non-monetary factors and that a stronger hryvnia would harm exporters, raising the current account deficit.
"In the first quarter of 2008, nominal government expenditures increased just under 50 percent, pushing up public sector wages and sending a highly inflationary signal to the private sector," it said.
"Loose income policy continues to affect goods prices via second-round effects."
The agency lambasted the government of Prime Minister Yulia Tymoshenko in January, calling its fiscal policies "populist" after it began paying compensation to people who's Soviet-era savings were wiped out by hyperinflation during the 1990s.
Tymoshenko has repeatedly said that the government would be able to bring inflation under control in a few months, and some officials had even predicted deflation during the summer months due to bumper food harvests.
The government has not yet changed its 2008 inflation forecast of 9.6 percent after accumulated price rises in the first four months of the year, at 13.1 percent, exceeded the target. In 2007, inflation reached 16.6 percent.
Analysts have forecast inflation at around 20 percent for this year, while the central bank said it could hit 18-19 percent.
Source: Guardian UK