BNR Board decisions on monetary policy

The annual adjusted CORE2 inflation rate rose more steeply in the first month of Q2, also compared to forecasts, with its upward trend however softening subsequently, and reached 9.1 percent in May, from 7.1 percent in March, particularly under the influence of new significant increases in processed food prices. Specifically, the evolution of this component continues to reflect the effects of the surges in commodity prices, mainly agri-food prices, and of elevated energy and transport costs, alongside the influences of production chain bottlenecks, compounded by high short-term inflation expectations, the resilience of demand in certain segments, as well as by the significant share of food items and imported goods in the CPI basket.

Therefore, the step-up in annual inflation rate in the first months of Q2 was further driven by global supply-side shocks, amplified by the war in Ukraine and the sanctions imposed, which triggered and fuelled the strong rise in inflation worldwide, to unprecedented levels over the last decades in developed economies, including in many European countries.

Average annual CPI inflation rate and average annual inflation rate calculated based on the Harmonised Index of Consumer Prices (HICP – inflation indicator for EU Member States) went up to 8.3 percent and 7.1 percent respectively in May, from 6.5 percent and 5.6 percent respectively in March 2022.

Economic activity stepped up in 2022 Q1 at a stronger-than-foreseen pace, adding 5.2 percent against 2021 Q4, when it grew by 1.0 percent quarter on quarter. This renders likely a visibly higher-than-expected resurgence in positive output gap in this period, albeit relatively moderate.

In 2022 Q1, annual GDP dynamics advanced to 6.5 percent from 2.4 percent in 2021 Q4, significantly above expectations. However, behind the strengthening in GDP growth rate stood mainly the change in inventories, while the contribution of private consumption – coming second in terms of size – owed to some sub-components other than purchases of goods and services, which reported a markedly lower increase in annual terms during this quarter, inter alia amid a base effect. A notable contribution was also made by gross fixed capital formation, as a result of the strong re-acceleration against the same year-earlier period of both net investment in equipment (transport equipment included) and new construction works.

At the same time, during this quarter, net exports no longer made a negative contribution to annual GDP dynamics, as the increase in the annual change in the export volume of goods and services outpaced that in the import volume. However, the annual increase in the negative trade balance re-accelerated, primarily amid the relatively more unfavourable developments in import prices, while the current account deficit saw a considerably faster deepening trend against the same period of the previous year, inter alia as a result of the strong worsening in the dynamics of the primary income balance, on account of outflows of reinvested earnings and distributed dividends.

The recent developments in high-frequency indicators point to a quasi-standstill of economic activity in Q2, under the impact of the war in Ukraine and the associated sanctions, which implies a marked decline in the annual GDP growth rate during this period.

Thus, the data for April 2022 show a deceleration in the annual growth of retail trade and motor vehicle and motorcycle trade, as well as a larger contraction in annual terms in the industrial output, concurrently with the notable slowdown in the dynamics of new manufacturing orders. Moreover, in April, the volume of construction works recorded a significant drop from the same year-earlier period, mainly owing to developments in the residential and non-residential segments, but also following the steeper fall in civil engineering works.

However, the number of employees in the economy continued to grow in March-April, at an even somewhat swifter monthly pace that was almost entirely ascribable to hiring in the private sector, and the ILO unemployment rate declined gradually over the last months to 5.4 percent in May, yet remaining visibly above pre-pandemic values. Furthermore, the labour shortage reported by companies posted a faster rise in Q2, tending to near the levels prevailing prior to the pandemic, while the hiring intentions for the near-term horizon increased, but in the context of mixed sectoral developments, probably explained mostly by the effects and uncertainties generated by the war in Ukraine and the sanctions imposed.

Looking at the financial market, the main interbank money market rates have risen at a faster pace in the recent period, prompted by the monetary policy rate hike in May and the central bank’s firm control over market liquidity, but also amid expectations on an increase in the key rate, strengthened by the BNR’s messages and the decisions of central banks in the region. In turn, yields on government securities steepened their upward path, especially for the short and medium maturities.

This occurred, inter alia, in the context of a brief sell-off episode on bond markets, entailed by expectations on a faster normalisation of the monetary policy conduct by the Fed and the ECB, as well as amid the further deterioration of financial investor sentiment vis-à-vis some markets in the region. At the same time, the average remuneration of new time deposits grew at a considerably swifter tempo in April and May, even in the case of households. At this juncture, the EUR/RON exchange rate remained relatively stable in May and June as well.

The double-digit annual growth rate of credit to the private sector stepped up further in the first months of Q2, reaching 16.5 percent in May and 16.16 percent during the period overall, as the particularly strong dynamics of the leu-denominated component remained relatively steady and were accompanied by a renewed pick-up in the pace of increase of forex loans. The share of leu-denominated loans in credit to the private sector thus remained unchanged at 72.7 percent.

According to current assessments, the annual inflation rate will stick to an upward path until mid-Q3, under the impact of supply-side shocks, yet at a visibly slower pace, thus climbing moderately above the values forecasted in May over the short time horizon.

Behind the worsening of the near-term inflation outlook stand the higher dynamics anticipated over the following months for the prices of fuels, natural gas and electricity – even amid the support schemes in place and some base effects –, as well as for processed food prices. This is mainly ascribable to the stronger advance in crude oil, energy and agri-food commodity prices, owing to the war in Ukraine and the associated sanctions. Additional inflationary effects are also expected from administered prices, inter alia as a result of the National Railway Company raising ticket prices, as well as from tobacco product prices, following the increase in the specific excise duty.

Uncertainties are, nevertheless, associated with the presumed impact, but also the duration of energy and fuel price capping and compensation schemes. Moreover, notable risks continue to come from developments in energy commodity prices, as well as from the persistence of bottlenecks in production and supply chains, amid the war in Ukraine and the related sanctions, to which add those stemming from the recently announced measures for increasing budget revenues.

The protraction of the war in Ukraine and the expansion of sanctions against Russia generate, however, considerable uncertainties and risks to the outlook for economic activity, hence to medium-term inflation developments, through the possibly stronger effects exerted, via multiple channels, on consumer purchasing power and confidence, as well as on firms’ activity, profits and investment plans, but also by potentially affecting more severely the European/global economy and the risk perception towards economies in the region, with an unfavourable impact on financing costs.

The absorption of EU funds, especially those under the Next Generation EU programme, is conditional on fulfilling strict milestones and targets for implementing the approved projects. However, it is essential for carrying out the necessary structural reforms, energy transition included, but also for counterbalancing, at least in part, the contractionary impact of supply-side shocks, compounded by the war in Ukraine and the related sanctions, as well as the effects of fiscal consolidation. It is vital to reap the full benefits of these resources.

Rising uncertainties and risks are also associated, however, with the fiscal policy stance, given the requirement for further budget consolidation amid the excessive deficit procedure and the overall tightening trend of financing conditions, yet in a challenging economic and social environment domestically and globally, which led to the implementation of several packages of measures to support households and firms, with potential adverse implications for budget parameters.

Particularly relevant are also the ECB’s and the Fed’s prospective monetary policy stances, as well as the size and pace of increase of key rates by central banks in Czechia, Poland and Hungary.

In the meeting held today, 6 July 2022, based on the currently available data and assessments, as well as in light of the very elevated uncertainty, the NBR Board decided to increase the monetary policy rate to 4.75 percent per annum from 3.75 percent per annum as of 7 July 2022. Moreover, it decided to raise the lending (Lombard) facility rate to 5.75 percent per annum from 4.75 percent per annum and the deposit facility rate to 3.75 percent per annum from 2.75 percent per annum, as well as to maintain firm control over money market liquidity. Furthermore, the BNR Board decided to keep the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions.

The BNR Board decisions aim to anchor inflation expectations over the medium term, as well as to foster saving through higher bank rates, so as to bring back the annual inflation rate in line with the 2.5 percent ±1 percentage point flat target on a lasting basis, in a manner conducive to achieving sustainable economic growth.

The BNR closely monitors developments in the domestic and international environment and will continue to use the tools at its disposal to achieve the fundamental objective of price stability in the medium term.

The account (minutes) of discussions underlying the adoption of the monetary policy decision during today’s meeting will be posted on the BNR’s website on 18 July 2022 at 3:00 p.m.

In line with the announced calendar, the next monetary policy meeting of the BNR Board will be held on 5 August 2022, when a new quarterly Inflation Report is to be examined.