BNR’s concerns regarding the domestic economy and the monetary policy

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The minutes of the monetary policy meeting of the National Bank of Romania Board held on 6 November 2019 has been released today. During that meeting, the BNR Board discussed and adopted the monetary policy decision, based on the data and analyses on the recent characteristics and the updated forecast of medium-term macroeconomic developments submitted by the specialised departments, as well as on other available domestic and external information.

Among the central bank’s concerns there are the ones related to the pay rises, the slowdown of the economy the new IRCC index or investments.

Board members showed that, in September, the annual inflation rate had fallen to the upper bound of the variation band of the target (down to 3.5 percent from 3.9 percent in August), thus declining slightly more than expected in Q3. The drop versus June was entirely attributable to the exogenous CPI components, namely the slower dynamics of vegetable prices and administered prices, as well as of fuel prices, on account of the developments in the oil price; their influences had markedly exceeded the opposite impact exerted by the hike in the tobacco product prices, as well as by the evolution of core inflation.

Specifically, the annual adjusted CORE2 inflation rate had followed further an upward trend in Q3, albeit at a slower pace than expected, going up from 3.3 percent in June to 3.4 percent in September. It was noted that the advance had been triggered that time round by both the food segment – only partly under the influence of the pick-up in some agri-food prices such as pork meat – and the non-food segment, being however slowed down by the probably incidental price decreases in telecommunication services, in spite of a mild depreciation of the leu against the euro.

According to Board members’ assessment, the developments in core inflation indicated significant demand-pull and wage cost-push inflationary pressures, in line with the size and trend of the cyclical position of the economy and of the private consumption dynamics, as well as with the sustained rise in labour costs. In that context, it was underlined that average gross nominal wage earnings, as well as net real wage earnings, had further displayed annual two-digit increases over the last months. It was deemed that wage pressures would remain relatively elevated in the immediately forthcoming period, reference being made to labour market tensions – amplified by structural problems –, to some survey outcomes showing positive hiring intentions, albeit obviously weaker in the short run, as well as to the demonstration effect of public sector wage dynamics – expected to moderate, however, in the future. Some Board members drew attention to the acceleration trend of the annual growth rate of unit wage costs in industry, which, in the first months of Q3, had reached a 10-year high, inter alia amid labour productivity losses. Also relevant from the perspective of inflationary pressures were considered the upward annual dynamics of industrial producer prices for consumer goods on the domestic market, as well as the high GDP deflator in Q2, only slightly below that in the previous period, alongside the high/mildly higher short-term inflation expectations.

As for the cyclical position of the economy, Board members remarked that the second provisional version of statistical data on GDP developments in Q2 was virtually unchanged, reconfirming the slightly wider-than-expected opening of the positive output gap in that period. The contribution of private consumption to the economic advance turned out to have been, however, prevalent in Q2 too, yet followed closely by that of gross fixed capital formation – given the markedly faster rise in new construction works – and, at a greater distance, by that of general government consumption. The overall contribution of domestic demand to GDP dynamics had, however, posted a more obvious decrease versus Q1, on account of the change in inventories, whereas net exports had reported a further smaller negative contribution. The latter had occurred in the context of a more pronounced narrowing of the negative differential between the growth rates of exports and imports of goods and services, also reflected by the significant slowdown in the pace of increase of the negative balance on trade. The current account deficit had continued, however, to widen year on year at a fast pace, similar to that in the previous quarter, as a result of the marked worsening of the primary and secondary income balances. Some Board members considered, nevertheless, that, apart from the slight favourable revisions of some statistical data, the overall picture remained essentially unchanged, with the widening trend of the external imbalance being particularly worrisome, especially in the context of the deterioration of the economic conditions in the euro area and worldwide.

Board members agreed then that the recent developments and assessments continued to indicate a more pronounced deceleration in economic growth in H2, mainly amid a more modest performance of agriculture, likely implying a standstill of the positive output gap at the level recorded in Q2, i.e. slightly below the previously-forecasted levels. The latest evolutions also suggested relatively equal contributions to economic growth in Q3 made by private consumption and gross fixed capital formation, in the context of a potential slowing in the annual dynamics of both components. The negative contribution of net exports was, however, likely to widen, considering that the annual increase in trade deficit in July-August had posted a renewed acceleration versus the Q2 average amid a stronger moderation in the annual growth rate of exports than in that of imports of goods and services. Nevertheless, the annual dynamics of the current account deficit had considerably decelerated during that period, owing to the improvement in the primary and especially the secondary income balances. The latter had been, nonetheless, ascribable to a base effect, while the coverage of the current account deficit by autonomous capital flows had continued to deteriorate, some Board members warned.

Looking at monetary conditions, Board members showed that in October the main ROBOR rates had continued to decline slightly, remaining however significantly above the monetary policy rate. At the same time, in the context of the NBR mopping up the excess liquidity on the money market through deposit-taking operations, the average interest rate on interbank transactions had recorded only a very modest decline versus Q3, its negative spread widening, however, vis-à-vis the monetary policy rate and particularly versus the benchmark index for loans to consumers (IRCC), which had increased marginally to 2.66 percent in Q4. In addition, in September, the average lending rate on new business had witnessed only a small correction of the large decreases seen in the previous months – considerably attributable to the pick-up in the volume of secured loans to the agricultural sector –, so that its quarterly average had dropped significantly versus the first two quarters of the year, even amid a sizeable rise in the IRCC, carrying the potential to enhance the uncertainties generated by that benchmark index from the perspective of the monetary policy transmission and conduct.

Furthermore, it was noted that the recent evolution of the EUR/RON exchange rate had somewhat decoupled from that of the exchange rates of the other currencies in the region, which, in the context of an improvement in global risk appetite, as well as of some domestic influences, had witnessed notable declines in October, recovering entirely or to a large extent the increases seen in Q3. It was deemed that a lower EUR/RON exchange rate, possibly triggered by the interest rate differential – especially amid the monetary policy easing by the Fed and the ECB, as well as the conduct of central banks in Central and Eastern Europe –, could support disinflation in the short run, yet would induce great risks to medium-term inflation developments, via the adverse impact on the trade balance and current account. Nevertheless, some Board members drew attention to the risk of a potential sudden change in the global financial market sentiment, implying significant capital movements that could seriously affect the domestic financial environment, calling on the central bank, especially in the context of the twin deficits, to be alert and prepared for a potential necessary prompt reaction.

Board members also noted that credit to the private sector had further witnessed in September a robust annual growth, which had moderated only slightly versus the earlier month, its average dynamics for Q3 picking up to a level marginally below the 7-year peak reached in Q1. The slight deceleration in September had been mainly ascribable to loans to non-financial corporations, whereas the rate of change of household credit had advanced marginally, amid the further strong, double-digit increase in domestic currency loans.

As for future developments, Board members concluded that inflationary pressures in the economy were expected to abate across the policy-relevant horizon, also compared with the August forecasts, but to remain significant and slightly regain momentum starting 2020 H2. It was shown that, after a modest climb above the variation band of the target in December 2019, to 3.8 percent, the annual inflation rate would probably fall comfortably in the upper half of the band in 2020 H1. It would thereafter re-embark on a slowly upward path, tending to near the upper bound of the band again, to reach 3.1 percent in December 2020 and 3.2 percent at the end of the forecast horizon. The new anticipated values of the annual inflation rate were visibly lower than previously projected, especially over the short term, as the forecast published in the August 2019 Inflation Report had envisaged levels of 4.2 percent, 3.4 percent and 3.3 percent respectively for the same moments in time.

Board members remarked that the lower values anticipated to be recorded by the annual inflation rate over the short time horizon, as well as its likely downward correction in 2020 H1 were almost entirely attributable to the action of supply-side factors. Major influences stemmed from the larger/incidental declines seen recently in vegetable prices and the prices for telecom services respectively, as well as from the base effects associated with previous developments in VFE, tobacco and fuel prices, but also with the tax levied on the telecom sector, whose joint impact was counterbalanced only to a small extent by that anticipated to come from administered price dynamics. Several members warned, however, that the latter might sizeably exceed the forecasts, amid the probable relaunch next year of the liberalisation of electricity and natural gas prices.

Moreover, it was pointed out that fundamentals were expected to further exert significant and mildly rising inflationary pressures, albeit slightly weaker than previously projected, given the forecasts on the cyclical position of the economy, wage costs, as well as import price dynamics, reflecting inter alia the expected developments in the leu exchange rate. It was noted that, at the level of core inflation, they would however be somewhat masked in the first part of 2020 by the disinflationary base effects of the 2019 supply-side shocks, i.e. the introduction of the telecom sector tax, as well as the increase in prices of some agri-food commodities, although more modest in the recent period than previously anticipated. Under the circumstances, the annual adjusted CORE2 inflation rate was expected to remain at 3.4 percent in December 2019 – slightly below the previously projected level of 3.9 percent – and to decline in the first part of next year to values visibly lower than those forecasted in August. Yet, it was anticipated to resume growth afterwards and climb gradually to 3.2 percent in December 2020 and 3.4 percent at the end of the projection horizon, versus 3.6 percent in the earlier forecast for both moments in time.

As regards the prospects for the cyclical position of the economy, Board members remarked that economic expansion would probably remain solid across the forecast horizon, amid a gradual slowdown 2019 through 2020, followed nevertheless by a renewed step-up in 2021. Even in the context of the new outlook – less optimistic in the short run than envisaged in August –, the pace of economic growth was expected to markedly exceed the potential rate in 2019 and then to remain relatively in line with the latter, several members underlined; thus, excess aggregate demand would likely rise considerably in 2019, hitting a post-crisis high, and afterwards fluctuate around that level, although recording lower values than previously forecasted.

Furthermore, according to assessments, household consumption would probably become again in 2020 and remain thereafter the main driver of economic growth, amid the robust, albeit decelerating dynamics of real disposable income – reflecting inter alia the drop in inflation rate and the increase in social transfers –, as well as in the context of real bank rates that were assumed to rise very slowly across the forecast horizon. Board members showed that, in an environment of labour market tightness, the rise in household income might even exceed the forecasts, whereas a more moderate-than-anticipated evolution would be possible assuming the implementation of measures aimed at mitigating the budget deficit deviation from the ceiling set under the Stability and Growth Pact; such measures would also affect consumer confidence, highly sensitive to developments/events adversely impacting households’ current/anticipated financial standing.

Board members deemed that considerably higher uncertainties and risks surrounded the investment outlook, which implied, in turn, protracted stimulative influences from the pro-cyclical fiscal policy across the projection horizon. Also in the context of the election calendar, they stemmed primarily from the future budget construction, given the considerable widening of the budget deficit in 2019 – worrisome inter alia in terms of domestic and external financing costs –, as well as the stronger anticipated budget impact of the new pension law. This would likely render necessary measures to halt the deterioration of the fiscal position, probably materialising, at least over the short term, in the reduction of public investment expenditures, including those financed from EU funds. Uncertainties also continued to arise from the financial standing of companies, as well as from resident and non-resident investors’ confidence – conditional on the quality of the business environment, including the stability and predictability of the legislative framework –, but also from the decelerating trend of the European and global economies and the associated uncertainties, with a contractionary impact on domestic industrial output and possibly on foreign direct investment.

A matter of particular concern was considered the prospective further deterioration of the current account and of the economy’s overall external position, likely to induce risks to macro-stability, but also to the sustainability of economic growth, especially in the current global economic and financial context, marked by adverse implications and uncertainties stemming from the trade war and Brexit. In the assessments conducted, Board members referred to the discrepancy between the robustness of domestic absorption and the softening of external demand, as well as to non-price competitiveness issues in some sectors, but also to price competitiveness losses recorded by some companies, amid the sustained increase in wage costs and the quasi-stability of the leu exchange rate. Several Board members reiterated the need for an orderly correction of the external imbalance, underpinned primarily by a fiscal adjustment, alongside significant structural reforms, which however required time.

The need for a balanced macroeconomic policy mix to avoid the overburdening of monetary policy, with undesired effects in the economy, was again underlined. Moreover, the importance of an adequate dosage and pace of adjustment of the monetary policy stance was reiterated, with a view to anchoring medium-term inflation expectations and bringing the annual inflation rate back into line with the inflation target, while safeguarding financial stability. At the same time, it was deemed that, given the macroeconomic conditions and the domestic and external risks, maintaining strict control over money market liquidity was of the essence.

Under the circumstances, the NBR Board unanimously decided to keep unchanged the monetary policy rate at 2.50 percent, while maintaining strict control over money market liquidity; moreover, the deposit facility rate was left unchanged at 1.50 percent and the lending (Lombard) facility rate at 3.50 percent. In addition, the NBR Board unanimously decided to maintain the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions.


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