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Minutes of the monetary policy meeting of the National Bank of Romania Board on 2 April 2019

Release date: 9 April 2019

The National Bank of Romania Board members present at the meeting: Mugur Isarescu, 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; Liviu Voinea, Board member and Deputy Governor of the National Bank of Romania; Marin Dinu, Board member; Daniel D?ianu, 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 consumer price dynamics, Board members showed that the annual inflation rate had risen to 3.32 percent in January and to 3.83 percent in February 2019 from 3.27 percent in December 2018, thus climbing above the variation band of the target and above the forecast. All major CPI components had posted higher-than-expected increases, but the step-up in the inflation rate had been mostly driven by developments in the prices of vegetables and fruit to which had added the dynamics of tobacco product prices and of core inflation.

It was noted that the annual adjusted CORE2 inflation rate had resumed growth more strongly than anticipated – reaching 2.7 percent in February from 2.4 percent in December 2018 – and that its re-acceleration had been triggered by non-food items and, to a somewhat lesser extent, by services, also partly reflecting the impact of a weaker leu against the euro and the indirect effects of the advance in fuel prices. Food items had also tended to become slightly inflationary again, given the fadeout of corrections in the international prices of some agri-food products. Some Board members deemed that overall developments in core inflation reflected rising demand-pull and wage cost-push inflationary pressures, in line with the likely strengthening of the cyclical position of the economy in 2018 Q4 and the faster increase in consumer demand amid the re-acceleration of real wage growth, as well as with the sustained pick-up in unit labour cost. The slightly upward trend in the annual dynamics of industrial producer prices on the domestic market for consumer goods was also seen as indicative, but at the same time reference was also made to the drop in the GDP deflator to 104.3 percent in 2018 Q4 from 106.4 percent in Q3.

Turning to the cyclical position of the economy, Board members remarked that, as expected, economic growth had remained little changed at 4.1 percent in 2018 Q4 year on year, in the context of a slowdown in the quarterly pace of increase that made it likely for excess aggregate demand to rise slightly in that period, as forecasted. Moreover, according to expectations, household consumption had yet again become the main driver of economic expansion, well ahead of the contribution from the change in inventories, whereas gross fixed capital formation had made a slightly lower negative contribution to GDP growth. By contrast, net exports had continued to make a larger negative contribution against the background of the protracted slowing trend in the growth rate of exports of goods and services, in parallel with the slight re-acceleration of import dynamics, also conducive – alongside a more pronounced worsening of the primary income balance – to a significant widening of the current account deficit in that period. The ensuing rise in the current account deficit to 4.5 percent of GDP in 2018 from 3.2 percent in 2017 – suggesting external competitiveness losses of the economy – and its lower coverage by autonomous capital inflows were deemed to be serious reasons for concern by some Board members, who viewed such developments as calling for increased attention. However, reference was also made to structural causes of external deficit, which had become chronic over time, and to the relatively lower level of subsidies from EU funds to the benefit of Romanian farmers.

In that context, it was noted that, in 2018, economic growth, which had slowed down to 4.1 percent from an exceptional 7 percent in 2017, had been underpinned, on the demand side, only by consumption, especially household consumption, and by the change in inventories, while gross fixed capital formation and particularly net exports had eroded the GDP increase.

Board members also continued to voice concerns over the high degree of labour market tightness, citing the new low hit by the ILO unemployment rate at the start of 2019, concurrently with new historical highs for the number of employees in the economy, as well as the still robust hiring intentions in the near term, albeit softening somewhat, as indicated by surveys. The large labour shortfall facing certain market segments – compounded by structural problems as well – alongside the demonstration effect of public sector wage hikes would heighten wage pressures in the future and therefore could dent the competitiveness of some sectors. It was remarked that the annual growth rate of average gross nominal wage earnings had regained significant momentum in January 2019 and the advance in average net real wage earnings had sped up even faster, thus returning to a two-digit range, due inter alia to the slowdown in the annual inflation rate; in addition, the annual dynamics of unit wage costs in industry had almost doubled in the first month of 2019.

Relative to monetary conditions, Board members pointed out the return to higher levels of key interbank money market rates in February-March, and implicitly of their positive spread vis-à-vis the monetary policy rate, amid the tightening of liquidity conditions on the money market, as well as the drop in interest rates on households’ time deposits in the first two months of 2019. At the same time, it was observed that the EUR/RON exchange rate had remained close to the historical high reached in the second half of January for most of Q1. Some Board members remarked that, in the context of the ongoing deterioration of the external position of the economy, an increase in pressures on the exchange rate was very likely – with an adverse impact on inflation and on confidence in the domestic currency –, especially in the event of a sudden change in the global financial market sentiment that could trigger a risk repricing. The possible change in the risk perception vis-à-vis the local economy/financial market was also mentioned.

It was also observed that the annual growth rate of credit to the private sector had continued to pick up in January, but had lost some momentum in February, its average for the period as a whole rising markedly against 2018 Q4. This evolution had reflected the annual dynamics of leu-denominated loans staying at double-digit levels, albeit slightly on the wane, but especially the considerable slowdown in the decline of the foreign-currency component, amplified as a statistical effect by the increase in the EUR/RON exchange rate. Against that background, the share of the leu-denominated component in total private sector credit had narrowed marginally to 65.7 percent.

As for future developments, Board members showed that, according to the latest information and analyses, the annual inflation rate would probably remain above the upper bound of the target band over the short time horizon and on a significantly higher path than in the medium-term forecast published in the February 2019 Inflation Report (3.0 percent in December 2019 and 3.1 percent at end-2020). It was noted that the relative worsening of near-run inflation outlook was only partly ascribable to past performance, clearly also reflecting the likely less disinflationary action of supply-side factors in the future, given the envisaged much quicker dynamics of prices of vegetables, fruit, eggs and of fuel, compared to the February forecast, as well as relatively stronger effects expected from the new taxes levied in telecom and energy sectors. Even in those circumstances, the balance of risks associated with the new projections remained prevailingly tilted to the upside, as some Board members pointed out, warning that a potential materialisation of those risks would likely pose risks to medium-term inflation expectations.

Moreover, the action of fundamentals would probably be relatively more inflationary than previously anticipated over the short time horizon, with rising pressures being expected from aggregate demand and wage costs, as well as from the leu’s exchange rate movements. Specifically, looking at the premises of the cyclical position of the economy, Board members concluded that economic growth would probably remain robust in 2019 H1, with small changes in annual dynamics during the two quarters and a relatively steady quarterly rate, implying further increases in the positive output gap during that period on a trajectory only marginally lower compared to the February medium-term projection.

Furthermore, it was observed that, based on the most recent developments in relevant indicators, private consumption would likely be the chief driver of economic growth in 2019 Q1 as well, but opposite influences might come from gross fixed capital formation. Net exports were even expected to increase their negative contribution to GDP growth, given that the annual pace of widening of trade deficit had regained strong momentum in January, amid a slowdown in the annual rate of increase of exports, along with a slight renewed pick-up in the annual growth of imports of goods and services. Against that backdrop, it was noted that the annual dynamics of the current account deficit had followed a steeper upward trend in January, posing a concern in terms of the sustainability of economic growth and macro-stability.

Board members deemed that the reviewed economic developments could fuel uncertainty and risks to the most recent medium-term projection, considering that important uncertainty sources were also the future fiscal and income policy stance, as well as the fiscal and budgetary measures effective this year, which were likely to exert significant effects on economic activity and the economy’s growth potential via both the fiscal impulse coupled with public expenditure composition and the impact on investors’ and consumers’ behaviour. Mention was also made of the relative volatility of consumer confidence, which had, however, recently re-embarked on an upward course, and of labour market conditions, but also of the features of EU funds absorption and public investment spending.

It was noted that major uncertainties and elevated risks were associated with the external environment as well. Board members mentioned the economic slowdown at European level and the recent downward revisions of the outlook for EU and global growth, and hence the euro area inflation forecast, as well as the heightened uncertainties surrounding the impact of Brexit and trade rows. The recent change in perspective of the ECB’s monetary policy stance and the probable stance of central banks in the region were considered highly relevant.

Discussions also addressed the recent changes to a number of legislative acts on the banking sector and their implications for monetary policy. According to the unanimous opinion, the amendments to GEO 114/2018 preclude hefty damages to the economy and satisfy the three requirements set forth by Board members, as submitted to the National Committee for Macroprudential Oversight and during talks with the Government. The new provisions altogether complicate, however, monetary transmission, with implications for the general framework of monetary policy. Some Board members emphasised the need for commercial banks to apply higher deposit rates.

Some Board members deemed that, given the macroeconomic conditions and the domestic and external risks, monetary conditions should be tightened; it was agreed that the adequate approach in the current environment was a strict control over money market liquidity.

Board members underlined 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, from the perspective of anchoring inflation expectations and maintaining the annual inflation rate on the trajectory shown by the NBR’s latest medium-term forecast, while safeguarding financial stability.

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. 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.