Central Bank: Uncertainties substantially up due to the coronavirus epidemic, downside risks to the inflation outlook in Romania

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Convened for an emergency meeting, the Board of the National Bank of Romania discussed and adopted the monetary policy decisions based on a report on the macroeconomic and financial developments recently recorded and anticipated for the near term, as well as on a document presenting monetary policy decisions adopted in emergency meetings by central banks in Central and Eastern Europe, and on other available domestic and external information.

Analysed data showed that, in the first two months of 2020, the annual inflation rate had dropped at a fast pace and had thus returned into the upper half of the variation band of the target, falling to 3.6 percent in January from 4.04 percent in December 2019, and to 3.05 percent in February, in line with expectations. The downward correction had owed almost entirely to the decelerations seen in the prices of fuels and VFE, and, to a much lower extent, to declines in the change of tobacco product prices and administered prices, mainly ascribable to base effects and the influence from removing the special excise duty on motor fuels and from the unanticipated fall in the oil price.

Core inflation had also made a minor, lower-than-anticipated contribution, as the annual adjusted CORE2 inflation rate had continued its upward movement into January, contrary to expectations, climbing to 3.74 percent from 3.66 percent in December 2019, and had decreased to 3.60 percent in February, inter alia amid some disinflationary base effects, thus indicating further significant demand-pull and wage cost-push inflationary pressures.

At the same time, economic growth had re-accelerated way above expectations in 2019 Q4 (to 4.3 percent from 3.0 percent in Q3), in quarterly terms as well, making it likely for excess aggregate demand to have risen above expectations. Moreover, contrary to expectations, household consumption had become again the main driver of economic expansion during that period, its contribution being followed at quite a distance by that of gross fixed capital formation first and then by that of government consumption. The contribution of the latter had expanded considerably – to reach a peak since 2008 Q3 –, in the context of the fiscal deficit widening at year-end way above the 3 percent-of-GDP deficit limit under the Stability and Growth Pact. Net exports had nevertheless made a visibly lower negative contribution to GDP dynamics, amid a more pronounced slowdown in the growth rate of imports than in that of exports of goods and services, also reflected in the markedly slower annual increase of the negative trade balance. The current account deficit had however posted only a very slightly slower annual growth pace, whereas its coverage by FDI and capital transfers had seen a further downward trend.

In 2019 as a whole, the economic advance had therefore remained particularly robust, posting only a mild slowdown versus the previous year – to 4.1 percent from 4.4 percent –, given the moderation in private consumption dynamics and the pick-up in the negative contribution of net exports, but also amid the strong re-acceleration in gross fixed capital formation and the notable step-up in the growth rate of government consumption. The current account deficit-to-GDP ratio had expanded to 4.7 percent in 2019 from 4.4 percent in the previous year, while its coverage by FDI and capital transfers had decreased mildly, to around 78 percent from 83 percent in 2018.

At the same time, the latest monthly data – for January 2020 – had continued to suggest a robust economic growth in 2020 Q1, supported by private consumption and particularly by investment demand. Signals in that respect had come from the strong pick-up in annual terms in retail sales and services to households, the significant re-acceleration in the construction activity and the slower decline in industrial production, alongside the faster increase in new manufacturing orders, as well as from exports and imports of goods and services regaining momentum, amid the relative stabilisation of European and global economies. Lending had also remained strong, the annual dynamics of new loans touching a post-October 2015 high in January 2020.

The global economic picture had, however, started to worsen at a fast pace in mid-Q1, while the associated uncertainties had risen substantially, given the rapidly growing adverse impact of the COVID-19 pandemic on production and global supply chains as well as on demand, alongside the containment measures implemented in many countries, which would make it probable (in light of the recent developments) for the euro area and global economies to enter recession in the near term.

That had entailed a sudden worsening of the global financial market sentiment and the increase to extreme levels in the volatility of prices for all major asset classes. Amid a broad-based sell-off, bond markets in the advanced economies had also been affected by episodes of heightened tensions and liquidity squeeze, while financial markets in emerging economies had seen substantial capital outflows. Moreover, the international prices of oil and other commodities had plunged.

Against that backdrop, governments in many countries, as well as international and European institutions and bodies, had resorted to/announced extraordinary fiscal measures and programmes so as to mitigate the economic impact of the pandemic. At the same time, also in a bid to appease financial market turmoil, major central banks, as well as central banks in emerging economies, including those in the region, had proceeded to change abruptly or strengthen the path of monetary policy via measures taken, also in emergency meetings, to ease the policy stance and improve the financing conditions for the economy. Specifically, the Federal Reserve System had made a two-step cut, cumulating 150 basis points, in the target range of the federal funds rate, down to 0-0.25 percent, had resumed asset purchases and had increased the volume of liquidity injected into the financial system through reverse transactions, also lowering the reserve requirement ratios to zero.

The ECB had adopted in two meetings measures on rising considerably the volume of asset purchases, conducting additional longer-term refinancing operations and applying more favourable terms to targeted longer-term refinancing operations.

In the region, the Czech National Bank had lowered the monetary policy rate by 0.5 percentage points and had decided to preventively increase the frequency of the liquidity-providing repo facility that it had introduced and actively resorted to during the 2008 financial crisis. The Polish central bank had adopted an even more comprehensive package of measures. Aside from the reference rate cut by 0.5 percentage points and the additional narrowing of the corridor of interest rates on standing facilities, the package had provided for the reduction of the minimum reserve requirement ratio, repo operations to provide liquidity to credit institutions, purchases of government securities on the secondary market and the refinancing of the new loans granted by credit institutions to the non-financial sector.

Given the escalating international financial market volatility, key ROBOR rates in the domestic money market had discontinued their slight downtrend seen January through February 2020, before rising relatively steeply in the second 10-day period of March. In turn, interest rates on leu-denominated government securities had gone up significantly, especially over longer maturities, also amid worsening liquidity on the secondary market, developments visible at regional level as well. Moreover, at mid-February, the EUR/RON exchange rate had embarked on an upward path, which, however, had been considerably less steep than that seen in the exchange rates of the other currencies in the region.

At the same time, the preliminary assessments made in the current particularly fluid context had shown that the annual inflation rate might continue to decline in the near run, on a path even slightly lower than that projected in February, amid the plunging oil price. Furthermore, the abrupt halt in an increasing number of economic activities starting the latter half of March, in an effort to contain the spread of the COVID-19 pandemic, and the gradually shrinking consumer demand were likely to entail a sharp slowdown in first-quarter economic growth, followed by a quarter-on-quarter contraction, implying a drastic change in the course of Romania’s economy in 2020 H1, which could trigger downside risks to the inflation outlook over a longer horizon. Besides, the balance of risks to the preliminary assessments on economic growth, stemming from the very high uncertainty, had been clearly tilted to the downside.

Board members unanimously deemed that such an environment called for and warranted an immediate and decisive monetary policy response in order to curb the economic impact of the coronavirus pandemic, in addition to the front-line measures taken in the healthcare and fiscal areas, also bearing in mind the relatively narrower room available to fiscal policy for taking measures to support both companies and households at the current juncture. A prompt and well-calibrated response – also in terms of the employed monetary policy tools – was regarded as necessary also for ensuring and enhancing liquidity in the banking system, for the smooth functioning of the money market and other financial market segments, as well as for the adequate financing of the real economy and the public sector. Board members agreed that, at the current juncture, implementing a comprehensive package of monetary policy measures could help achieve a fast-track economic recovery after the coronavirus-induced contraction and hence ensure price stability over the medium term, in line with the 2.5 percent ±1 percentage point inflation target, while preserving financial stability.

Under the circumstances, the NBR Board unanimously decided to cut the monetary policy rate from 2.50 percent to 2.00 percent, as well as to narrow the symmetrical corridor defined by interest rates on standing facilities around the monetary policy rate to ±0.5 percentage points from ±1.0 percentage points. Thus, the deposit facility rate was kept at 1.50 percent, while the lending (Lombard) facility rate was lowered to 2.50 percent from 3.50 percent. Moreover, the NBR Board unanimously decided to carry out repo transactions to provide liquidity to credit institutions and to purchase leu-denominated government securities on the secondary market.

At the same time, the NBR Board agreed to also proceed to cutting the minimum reserve requirement ratios on leu- and foreign currency-denominated liabilities of credit institutions where necessary and depending on specific circumstances.

In view of the elevated uncertainty surrounding economic and financial developments, the NBR Board also decided to suspend the previously announced calendar of monetary policy meetings and hold monetary policy meetings whenever necessary for an indefinite period.

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