The Central Bank of Iran (CBI) increased its foreign exchange reserves by $4.5bn during the recent conflict with the United States and Israel, CBI Governor Abdolnaser Hemmati said, citing previously unreported figures. The bank was working to “ensure that the country’s currency needs would be met even if the conflict continued”, he said.

Hemmati’s and the Pezeshkian government’s effort to bolster foreign exchange reserves has unfolded alongside one of the most aggressive monetary tightening campaigns in the Islamic Republic’s recent history. The governor’s actions and recent comments set out a plan that veers considerably from that of his immediate predecessor, who was also battling severe inflation and crippling US sanctions.

Iranian policymakers and top financial officials appear to have concluded that the risk of renewed conflict, combined with widening fiscal deficits and accelerating inflation, poses a serious threat to the country’s monetary and political stability. In effect, they are trying to prevent a full-scale monetary crisis while contending with income streams stretched by US sanctions on international transactions.

Restricting bank liquidity

In its latest open market operation, the CBI supplied only IRR700 trillion ($402mn), nearly 19% of the banking system’s total liquidity demand of IRR3,620 trillion ($2.08bn). The allocation was unchanged from the previous week’s operation, suggesting the regulator’s restrictive stance is deliberate rather than temporary.

At the same time, another IRR700 trillion of previously injected liquidity matured and was withdrawn from the banking system. As a result, the central bank’s net liquidity injection was effectively zero.

The CBI now appears to view the risk of a new inflationary regime as a greater threat than either liquidity shortages or slowing growth. The concern is that inflation expectations may be becoming self-sustaining, creating a cycle in which households and businesses come to expect persistently high inflation, making it increasingly difficult for policymakers to restore price stability. Faced with that risk, the authorities appear to have concluded that some degree of financial stress is preferable to the loss of monetary stability.

The immediate trigger is clear enough to those following events inside the country. The recent war intensified inflationary pressures that were already building. It also increased fiscal pressures on the government and further weakened public confidence in the authorities’ ability to manage the economy, a challenge President Masoud Pezeshkian has recently recognised.

Alarming data

According to CBI data, money supply growth accelerated sharply in the aftermath of the February war and the subsequent ceasefire. By March 20, the end of the Iranian fiscal year, total money supply had exceeded IRR155,810 trillion ($89.5bn), representing annual growth of 53.3%, up from 29.1% a year earlier. Unofficial estimates suggest that by the end of the first quarter of the current Iranian year on June 21, total liquidity had risen above IRR160,000 trillion ($92bn).

Inflation rose sharply alongside the expansion in money supply. By June 21, annual inflation had reached 57.7%, while point-to-point inflation climbed to 83.1%, underscoring the growing pressures facing the economy. Notably, inflation data published by the Statistical Centre of Iran (SCI) have generally been higher than those reported by the CBI, suggesting that conditions may be more severe than official monetary data alone imply.

The greater concern for policymakers, however, appears to be the recent acceleration in monthly inflation, which reached 7.4%, 8.5% and 5.9% respectively in the first three months of the current Iranian year, which began on March 21. That translates into average monthly inflation of 7.3%. If sustained over the remainder of the year, inflation would approach 130% on an annualised, compounded basis.

These figures matter because they may indicate that inflation expectations are becoming entrenched. Once households and businesses come to expect persistently high inflation, their behaviour changes in ways that reinforce further price increases. At that point, inflation begins to feed on itself rather than merely reflecting underlying monetary conditions.

Preventing inflation from becoming self-sustaining appears to have become the authorities’ top priority. That helps explain the CBI’s recent policy choices in the repo market.

The repo squeeze

The central bank has held its repo rate at 23% despite government bond yields in secondary markets exceeding 40%. Predictably, banks have responded by sharply increasing their demand for central bank funding. The CBI, however, has restricted liquidity provision, tightening monetary conditions primarily through quantitative restrictions rather than higher policy rates.

The policy reflects broader developments in Iran’s political economy. In the eight years since the United States withdrew from the Joint Comprehensive Plan of Action (JCPOA) nuclear deal in 2018, Iran has operated under increasingly severe financial and economic sanctions. Annual inflation has since averaged approximately 44%, placing Iran among the world’s most persistently inflationary economies.

The national currency has been under unprecedented pressure over the same period. In early 2018, shortly before the US withdrew from the deal, one US dollar traded at slightly less than IRR50,000 on Iran’s unofficial foreign exchange market. Eight years on, by July 2026, the rate had reached around IRR1,750,000 per dollar, even after retreating from a peak of IRR1,900,000 amid reports of diplomatic efforts to end the conflict. In nominal terms, the dollar trades in Tehran at roughly 3,400% above its level of eight years ago. The dollar rate has become one of the principal measures by which Iranian households and businesses judge the competence of policymakers.

Exchange rate volatility has fuelled public anxiety and added new uncertainty for businesses. At the same time, rapidly rising prices, especially for food and other essentials, have heightened concerns about social unrest and political stability. Against this backdrop, Iranian policymakers appear to have reached a difficult conclusion: preventing a larger crisis may require accepting a smaller one.

Choosing the smaller crisis

The larger risk is an inflationary spiral. The smaller one is greater stress within the banking system. In other words, the authorities are willing to accept tighter financial conditions today to avoid a far more damaging inflation crisis tomorrow.

This helps explain why the central bank has tolerated mounting pressure on banks, slower credit growth and tighter liquidity conditions. The priority now is to preserve confidence in the currency and prevent inflation expectations from becoming entrenched, broadly the same strategy pursued after the 2015 nuclear deal between Tehran and Washington.

The challenge is that the government faces strong incentives to move in the opposite direction. War-related reconstruction costs, falling real incomes and growing social pressures all argue for more spending and easier monetary conditions, unlike the environment that prevailed after the 2015 deal. So far, however, the central bank appears to be resisting those pressures.

Whether the regulator can sustain the strategy remains uncertain. Iran’s banking system is structurally fragile, and prolonged liquidity shortages could increase financial stress, weaken credit growth and eventually force policymakers to reverse course.

Yet from the central bank’s perspective, those risks may now appear less dangerous than the alternative. After years of high inflation, followed by a post-ceasefire surge in money supply growth to more than 50%, Iranian policymakers have concluded that they are no longer simply fighting inflation. They are trying to prevent the emergence of a new inflationary regime, one that could become increasingly difficult to control.

Faced with a choice between protecting the banking system and protecting the currency, the central bank appears to have decided that the latter must come first, even at the cost of weaker credit growth and slower economic activity. Iran’s economy already contracted by 0.7% in the fiscal year to March 20. In practice, the CBI is embracing a form of monetary austerity. As one senior CBI official recently put it, controlling inflation and preserving the value of the national currency now require “iron discipline across all sectors of the economy”. Judging by the CBI’s recent actions, that discipline is no longer merely a slogan. It has become policy.

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Alireza Ramazani is the director of Iran Macro & Risk, which provides independent analysis of Iran's economy, political risk, financial markets and investment environment, drawing on public data, market developments and open-source research.