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Minutes of the monetary policy meeting of the National Bank of Romania Board on 3 October 2019

10 October 2019

The National Bank of Romania Board members present at the meeting: Mugur Is?rescu, Chairman of the Board and Governor of the National Bank of Romania; Florin Georgescu, Vice Chairman of the Board and First Deputy Governor of the National Bank of Romania; Eugen Nicol?escu, Board member and Deputy Governor of the National Bank of Romania; Marin Dinu, Board member; Gheorghe Gherghina, Board member; Ágnes Nagy, Board member; and Virgiliu-Jorj Stoenescu, Board member.

During the meeting, the Board discussed and adopted the monetary policy decision, based on the data and analyses on current and future macroeconomic, financial and monetary developments submitted by the specialised departments, as well as on other available domestic and external information.

Looking at the recent developments in consumer prices, Board members showed that the annual inflation rate had increased to 4.1 percent in July, while it had fallen to 3.9 percent in August, in line with forecasts, thus remaining above the 3.8 percent level seen in June and above the variation band of the target. It was noted that the rise versus June had been attributable to both the exogenous CPI components – given the hike in tobacco product prices and fuel price evolution, whose impact had been only partly counterbalanced by the slower dynamics of administered prices and VFE prices – and core inflation.

Thus, the annual adjusted CORE2 inflation rate had continued to rise – albeit at a milder pace, also against the forecast –, moving up from 3.3 percent in June to 3.4 percent in August, almost entirely on account of processed food prices. It was deemed that the hike in the latter reflected only partly the evolution of some international agri-food prices – particularly the increase in the pork meat prices in the context of the African swine fever – and that the loss of momentum reported during that period by services prices, despite a slight depreciation of the leu against the euro, could be incidental, owing largely to some cheaper services provided by a telecom company.

According to several Board members, the recent developments in core inflation indicated significant demand-pull and wage cost-push inflationary pressures, in line with the size and strengthening trend of the cyclical position of the economy – which had probably extended into Q2 –, as well as with the persistently strong dynamics of unit labour costs. To those added the further elevated or continually rising – in the case of some economic agents – short-term inflation expectations. Indicative from the perspective of inflationary pressures in the economy were also considered to be the faster pick-up in recent months in the annual growth rate of industrial producer prices on the domestic market for consumer goods and the GDP deflator standing in Q2 only marginally below the previous quarter’s level.

Turning to the cyclical position of the economy, Board members remarked that, in Q2, the economic expansion had witnessed only a modest deceleration to 4.4 percent from 5.0 percent in Q1, given a minor, below-expectations slowdown in its quarterly pace, likely implying a somewhat stronger-than-forecasted advance in excess aggregate demand in that period. Moreover, the contribution made by private consumption to the economic advance had remained significant, being, nevertheless, marginally exceeded by that of gross fixed capital formation, whose dynamics had reached a post-crisis high, owing, however, primarily to a faster rise in new construction works, with a relatively more modest impact on the economy’s future growth potential. At the same time, the negative contribution of net exports had diminished amid a more pronounced deceleration in the growth rate of imports than in that of exports of goods and services, but the current account deficit had posted a faster deepening against the same period of the previous year, as a result of the marked worsening of the primary and secondary income balances. Some Board members viewed the widening trend of the external imbalance, which distinguishes the Romanian economy from its regional peers, as particularly worrisome especially in the context of the almost general weakening of external economic growth and higher uncertainties surrounding its outlook.

Concerns were also voiced over labour market tightness, with discussions highlighting the difficulties facing companies in staff recruitment, especially of skilled labour, as well as the modest outcomes recorded in 2019 by internal mobility programmes. At the same time, it was noted that the slight decline in the job vacancy rate in Q2 was mainly attributable to the downsizing in industry and that the ILO unemployment rate had touched a new historical low in June at which it had subsequently tended to remain. Reference was also made to the positive, albeit relatively weaker, hiring intentions indicated by surveys for the coming period, as well as to the employers’ likely increased recourse to foreign personnel, in the context of the recent advance in the quota of newly-admitted workers to the Romanian labour market. Board members considered that, due to the large labour shortage, compounded by structural problems, wage pressures would remain elevated, at least over the short term, referring also to the two-digit annual dynamics further posted by average gross nominal wage earnings, but also by real net wage earnings in the last months, only mildly slower than in Q1. The two-digit annual dynamics of unit wage costs in industry had even risen noticeably during that period, in view of labour productivity losses.

Looking at monetary conditions, Board members showed that the main ROBOR rates had remained significantly above the policy rate in August and September, but had continued to decline slightly, whereas the interest rate on interbank transactions had seen a lower negative spread vis-à-vis the monetary policy rate during the period as a whole amid the steady mopping up by the NBR of excess liquidity on the money market through deposit-taking operations. The quarterly average of interbank rates had decreased, however, visibly against the previous quarter. Furthermore, the average lending rate on new business had recorded a pullback in July-August versus the Q2 average, mainly on account of loans to non-financial corporations, as well as consumer loans, even amid a marked hike in the IRCC as of the first day of Q3. However, the declines on the two segments were deemed to stem largely from the expansion during that period of the volume of collateralised loans to the agricultural sector, carrying also the potential to heighten the uncertainties caused by the IRCC from the perspective of monetary policy transmission and conduct, including in the context of the index remaining relatively flat in Q4.

At the same time, reference was made to the relative stability of the EUR/RON exchange rate for most of Q3, but also to its slight upward correction in mid-September, amid investors’ weaker appetite for assets on emerging markets, inter alia as a result of their expectations on the magnitude of monetary policy easing by the Fed and the ECB having been invalidated. Several Board members warned that, due to the considerable interest rate differential, the adjustment of the EUR/RON exchange rate had been markedly lower than the increase posted by the exchange rates of other currencies in the region, given the sizeable deficits resulting from Romania’s trade relations with those countries. However, some Board members drew again attention to the risk that the current external developments/events – the global disputes on trade and currency-related matters, Brexit and geopolitical tensions – might trigger sudden changes in global risk appetite, implicitly significant capital movements, which, in the context of twin deficits in particular, called on the central bank to be alert and prepared for a potential necessary prompt reaction.

Board members also noticed a relative step-up in lending, as the growth rate of credit to the private sector had picked up again slightly in the first two months of Q3, and its average dynamics had returned to the Q1 level, representing a 7-year peak. At the same time, the annual rate of change of the domestic currency component had again climbed to double-digit readings, strongly supported by new consumer credit, whose volume had reached a historical peak. The foreign currency component had also recorded faster dynamics, on account of loans to non-financial corporations, so that the share of leu-denominated loans in total private sector credit had increased only marginally to 66.7 percent in August.

As for future developments, Board members concluded that the annual inflation rate would probably remain above the variation band of the target until the year-end, on a trajectory slightly below that in the medium-term forecast published in the August 2019 Inflation Report, which had seen it at 4.2 percent in December 2019 and 3.3 percent at the end of 2021 Q2. The action of supply-side factors was deemed to continue to be slightly disinflationary September through October, before becoming moderately inflationary again in the closing two months of the year. Two-way influences were expected mainly from the recent and future developments in volatile prices, while constant effects, marginally more inflationary than in the previous forecast, were presumed from administered prices and tobacco prices. Conversely, some Board members drew attention to the fact that, over the longer time horizon, the dynamics of electricity and natural gas prices might sizeably exceed the previously-anticipated values, given the likely removal, in the short run, of restrictions imposed on the energy market via the legal acts in force. Nevertheless, reference was also made to the heightened uncertainties surrounding the near-term outlook for the oil price – amid the increasingly obvious weakening of the global economy and the volatility of geopolitical tensions –, as well as to the possibly higher-than-expected increase in this year’s agricultural output, with effects on the short-term evolution of food prices.

Board members showed that significant inflationary pressures would probably continue to be exerted in the near run by fundamentals as well, especially aggregate demand and wage costs. However, the inflationary pressures stemming from the cyclical position of the economy might be weaker than forecasted in August, given that economic growth was anticipated to decelerate relatively more visibly in H2, owing primarily to a more modest performance of agriculture, implying a standstill of the positive output gap in that period at the high valued recorded in Q2, i.e. slightly below the previously-forecasted levels. The assessment also took into account the slight favourable influences on potential GDP presumably stemming from the recent and future evolution of gross capital formation, whose contribution to economic growth equalled probably in Q3 too that of private consumption, as suggested by the recent values of high-frequency indicators.

Board members agreed that the short- and medium-term investment outlook was, however, marked by heightened uncertainties. The most prominent ones stemmed from the future fiscal and income policy stance, inter alia amid the 2019-2020 election calendar, given the characteristics of budget execution in the first eight months of the year, as well as the potential impact of the new pension law, which would render necessary, but also unavoidable, a fiscal correction in the future, with a view to bringing the budget deficit back within the ceiling set under the Stability and Growth Pact; it was agreed that adjustments were expected to be primarily made to investment spending, but that the moment of starting fiscal consolidation, as well as the pace and magnitude thereof were difficult to anticipate. Somewhat lower uncertainties continued to arise also from some budgetary practices, as well as from the frequent fiscal measures and legislative amendments implemented in the past years – affecting the companies’ profits and confidence –, but also from the pace of European funds absorption.

By contrast, heightened uncertainties and risks were deemed to be exerted by the external environment – both by means of foreign trade and through confidence and foreign direct investment –, amid the increased risks to the euro area and global economies posed by the trade war and Brexit, but also the easing of the major central banks’ monetary policy stances. In that context, Board members remarked that the negative contribution of net exports to the advance of the Romanian economy might have increased again in Q3, given the renewed acceleration of the annual growth of trade deficit in July, amid the marked slowdown in the annual dynamics of exports, alongside the faster rise in imports of goods and services. Moreover, the current account deficit had seen a faster deepening trend against the same period of the previous year – despite a relative improvement in the evolution of the primary and secondary income balances –, while its coverage by foreign direct investment and capital transfers had declined further.

In the assessments regarding the external imbalance – whose deepening was considered to increasingly become a matter of concern in terms of macro-stability and economic growth sustainability – Board members referred to the gap between the dynamics of domestic absorption and the softening trend of external demand; mention was also made of non-price competitiveness issues in some sectors, but also of price competitiveness losses recorded by some companies, amid higher wage costs and the quasi-stability of the leu exchange rate. Board members reiterated the need for an orderly correction of the external imbalance, underpinned primarily by a fiscal adjustment, alongside significant structural reforms, underlining again the need for a balanced macroeconomic policy mix to avoid the overburdening of monetary policy, with undesired effects in the economy. 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.