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Minutes of the monetary policy meeting of the National Bank of Romania Board on 12 November 2020

24 November 2020


On 12 November 2020, the Board of the National Bank of Romania held a meeting in which the following members took part: 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; Leonardo Badea, Board member and Deputy Governor of the National Bank of Romania; Eugen Nicol?escu, Board member and Deputy Governor of the National Bank of Romania; Csaba Bálint, Board member; Gheorghe Gherghina, Board member; Cristian Popa, Board member; Dan-Radu Ru?anu, Board member; Virgiliu-Jorj Stoenescu, Board member.


During the meeting, the Board discussed and adopted the monetary policy decisions, based on the data on and analyses of recent macroeconomic developments and the medium-term outlook submitted by the specialised departments, as well as on other available domestic and external information.


According to Board members’ assessment, the latest data and information showed a stronger recovery of the economy during the summer than anticipated at the August meeting, supported by government programmes and the NBR’s monetary policy measures; however, the rebound would probably come to a halt towards the end of the year or even see a slight reversal, in line with EU-wide developments, under the impact of the new pandemic wave and the related mobility restrictions.


It was shown that the annual inflation rate had decelerated to 2.45 percent in September from 2.68 percent in August and to 2.24 percent in October – running thus visibly below the projected level and slightly below the 2.58 percent level seen at end-Q2 –, mainly owing to the much larger-than-expected decline in the prices of fruit and vegetables. By contrast, the annual adjusted CORE2 inflation rate had remained flat at 3.7 percent in Q3, posting only a marginal slowdown to 3.6 percent in October, in line with forecasts, amid minor structural divergences. Specifically, the developments in the processed food segment had been mildly disinflationary, mostly on account of a base effect, while the services sub-component had exerted small opposite influences, inter alia in the context of the relative weakening of the leu against the euro, albeit markedly more moderate than that recorded in the region.


Following the analysis, Board members agreed that persistence had remained an important driver of core inflation behaviour and noted that the recent dynamics of the adjusted CORE2 inflation and short-term inflation expectations continued to be marked by the pre-pandemic underlying inflationary pressures. Other factors also deemed relevant were the strong recovery of consumer demand during the summer and the fast pace of wage costs, as well as the influences, albeit slightly milder, from supply-side disruptions/constraints and higher costs associated with the pandemic and with the measures to prevent the coronavirus spread. All of the above, along with the inherent time lags, were considered to have caused a delayed pass-through of the disinflationary effects from the aggregate demand deficit opened in Q2 to core inflation.


As for the cyclical position of the economy, Board members showed that, in line with expectations, the economy had witnessed a severe contraction in 2020 Q2 – by 10.3 percent in annual terms and by 11.9 percent in quarterly terms –, pushing the output gap abruptly into negative territory from the significantly positive reading in Q1. It was remarked that the contraction was overwhelmingly attributable to domestic demand, whose pull-back had been almost entirely generated by the plummeting household consumption, mainly on account of the purchases of services – strongly affected by the social distancing measures imposed during the state of emergency.


Contrary to expectations, gross fixed capital formation had, nevertheless, continued to rise mildly in annual terms amid the hike in equipment purchases and the resilience of the construction activity, while the annual dynamics of general government consumption had remained in the two-digit range, albeit on the wane versus the previous quarter.


The contractionary impact of net exports had been much more subdued than that of domestic absorption, but still substantial from a historical perspective, and only marginally lower than that in Q1, Board members pointed out, as the massive fall in exports of goods and services had outpaced visibly the drop in imports thereof, causing the annual dynamics of the negative trade balance to step up again. The current account deficit had, however, continued to narrow against the same year-earlier period, due to the considerably improved performance of the primary and secondary income balances, in annual terms, on account of the returns on equity holdings and inflows of EU funds.


For the period ahead, based on the latest data and assessments, Board members shared the view that in H2 the economy would probably recover a larger part of the contraction than anticipated in August, given a more significant upturn in Q3 – the poorer performance of agriculture notwithstanding – expected to come however to a halt or even see a slight reversal in the last months of the year, amid the resurgence of the pandemic and the imposition of new restrictions, although less severe than those in spring. That implied a more substantial narrowing of the aggregate demand deficit in 2020 H2, versus the previous forecast, on account of its contraction by more than two thirds in Q3 and its standstill at a slightly lower-than-previously-expected level in Q4 – that outlook was, however, surrounded by great uncertainties with the pandemic wave spreading across Europe and amid the associated restrictive measures.


According to high-frequency indicators, the economic rebound in Q3 was envisaged to be uneven across GDP components, Board members pointed out, with private consumption emerging as an important driver – after the decisive contribution to the severe contraction in the previous quarter –, whereas gross fixed capital formation could make a modest contribution, following the better-than-expected performance in the prior three months.


In the case of net exports, a positive contribution was also possible, given the slight shrinking of trade deficit in July-August versus the same year-earlier period, as a result of the annual decline in exports slowing much more visibly than that in imports of goods and services. Against that background, the current account deficit had resumed a faster narrowing against the same year-earlier period, benefiting inter alia by a further improvement in the primary income balance, mainly on account of lower outflows of distributed dividends and reinvested earnings. The coverage of the current account deficit by autonomous capital flows had started to deteriorate yet again, some Board members warned, in light of the large drop in foreign direct investment.


Board members remarked that the adverse effects of the pandemic on the labour market had been relatively contained so far, also when measured against expectations, given the resumption of activity in a large number of sectors after the gradual easing of restrictions, as well as due to the expansion of government’s support programmes for keeping the existing jobs. Thus, the decline in the number of employees economy-wide had virtually come to a halt in June, while the ILO unemployment rate had seen a slower rise in May-July, before even posting mild downward corrections in August-September to reach 5.2 percent.


The job vacancy rate had, however, continued to decline at a relatively fast pace in Q2, albeit unevenly across sectors, and hence the labour market had become less tight, yet amid structural changes revealed inter alia by stronger hiring intentions of firms performing essential activities or in compliance with social distancing. Under the circumstances, after the sharp slowdown recorded during the state of emergency as a result of the enhanced recourse to furlough, the annual growth of average gross nominal wage earnings had re-accelerated in June-July and remained flat in August, its average for the first two months of Q3 thus moving up close to the levels seen in the pre-pandemic months.


For the period ahead, the labour market could, however, be impacted by the worsening epidemiological situation, although some reports and surveys had underlined a mild improvement in employment intentions in early autumn. The adverse effects were nevertheless expected to be mitigated by the less stringent current restrictions, as well as by government’s support programmes that might be extended, Board members deemed.


Members showed that financial market conditions had continued to improve under the impact of the three successive policy rate cuts carried out March through August and on the back of the liquidity provided by the central bank to credit institutions, conducive to the adequate financing of the real economy and the public sector, amid the relative stability of the EUR/RON exchange rate.


Thus, key interbank money market rates had stuck to a downtrend in the past months, albeit relatively slower and marked recently by some small fluctuations, while yields on government securities had remained on a downward course, with 10Y bonds hitting four-year lows. In turn, the average lending rate on new business to non-bank clients had further gone down in Q3, dropping in September to the lowest reading in almost three years.


Moreover, the benchmark index for loans to consumers (IRCC) had followed a steeper downward path in the closing quarter of the year, the characteristics of the index remaining, however, a source of uncertainty as to the functioning of the monetary policy transmission mechanism, some Board members pointed out.


The recent fluctuations of the EUR/RON exchange rate – brought about by the heightened global risk aversion in the context of the new pandemic wave, but also by domestic political decisions posing risks to public finance sustainability – had, however, been far more moderate than those in the region.


Board members reiterated that preserving confidence in the domestic currency, in the context of widening twin deficits, was a key element of monetary policy conduct in 2020, implying a gradual and sustainable reduction in interest rates on the money market and on leu-denominated loans. At the same time, it was agreed that the public finance outlook and the heightening, in the electoral context, of the associated uncertainties were conducive to additional pressure on the sovereign risk premium, with potential consequences on the leu exchange rate volatility and, implicitly, on inflation and ultimately on financing costs and the pace of economic recovery.


It was observed that the annual dynamics of credit to the private sector had followed a slightly steeper upward path in September, after the shift in direction seen in August, reaching 4.0 percent, from 3.6 percent in July, amid the rebound in domestic currency lending, especially to non-financial corporations, also upheld by the IMM Invest Romania Programme.


Mention was also made of the stimulative influences exerted by the generally downward trend of interest rates, reflected inter alia by the further robust, only slightly decelerating, growth in leu-denominated housing loans. The annual dynamics of foreign currency credit had, however, continued to go deeper into negative territory, primarily on account of loans to non-financial corporations, with the share of leu-denominated loans in total credit thus climbing to a post-January 1996 high of 68.6 percent. Reference was also made to the rising trend in broad money growth August through September, correlated mainly with the faster dynamics of excess budget spending, implying also a very slight narrowing of the share of foreign currency deposits in that period.


Looking at future macroeconomic developments, Board members remarked that, in the new forecast, the anticipated pattern of inflation was revised only over the near-term horizon, when it would decline visibly below the previously-envisaged levels. Specifically, the annual inflation rate was expected to drop to 2.1 percent in December 2020 – versus 2.7 percent in the prior projection – and to 2.0 percent at the end of 2021 Q1, before climbing and remaining thereafter close to the mid-point of the target over the policy-relevant horizon, the same as in previous forecasts.


Furthermore, it was observed that behind the steeper deceleration of inflation over the short-time horizon stood the recent and anticipated developments in VFE prices, attributable to above-average crops of certain categories of vegetables and fruit, but also to the potential weakening of demand, amid the restrictions in some sectors given the new pandemic wave.


However, the overall action of supply-side factors would probably turn inflationary again starting in the first half of next year, mainly on account of some base effects, but also amid the electricity market liberalisation in January 2021, whose inflationary impact could be even more pronounced than that foreseen, as some Board members noted. It was deemed that stronger-than-expected upside influences could also come from some agri-food commodity prices and from the costs associated with coronavirus infection prevention measures, as well as from disruptions in production/supply chains and from the price-setting behaviour of some economic agents – all likely to affect core inflation developments.


Underlying disinflationary pressures would probably become slightly visible as of 2020 Q4, gaining prevalence only starting in mid-2021, Board members agreed. Alongside the gradual emergence of the disinflationary effects exerted by the aggregate demand deficit, behind the delay would stand the persistence of core inflation and the high increase in wage costs in the current year, which was anticipated to be corrected in 2021.


Over the near-term horizon, sizeable disinflationary influences were foreseen to stem, however, from import price dynamics, inter alia amid the probable developments in the exchange rate of the domestic currency, as well as from the base effects associated with the hike in some processed food prices, particularly of pork, Board members remarked.


Against that background, the annual adjusted CORE2 inflation rate would probably decelerate only slightly at end-2020, to 3.3 percent, the same as in previous forecasts, before witnessing a marked downward correction, declining in the latter part of next year and thereafter remaining below the mid-point of the target, at marginally lower-than-previously-anticipated values. Some members were of the opinion that core inflation might, however, prove relatively more persistent over the projection horizon, and implicitly less sensitive to the negative output gap.


Turning to the future developments in the cyclical position of the economy, it was shown that the new assessments pointed to a softer downturn in 2020 than that anticipated in August, amid the stimulative influences from government programmes and monetary conditions, but also to somewhat more modest growth in 2021, amid the new pandemic wave and the relatively weaker restoration of external demand. The outlook rendered likely a markedly slower narrowing of the aggregate demand deficit after the sizeable contraction in 2020 H2, implying the closure thereof slightly later than previously anticipated.


Board members repeatedly underlined that the uncertainties associated with the new outlook continued to be extremely elevated, triggering two-way risks to the future inflation path, amid the new pandemic wave, but especially in the absence – in the current electoral context – of the draft budget for 2021 outlining the future fiscal and income policy coordinates.


Reference was made to the resurgence of the pandemic across Europe and the possible protraction of the new wave, but also to the announcements on the availability of an effective vaccine in the near future, as well as to the less drastic mobility restrictions currently in place, alongside the enhanced capacity of households and economic agents to adapt to the health crisis.


It was considered that, via the potential impact on households’ real disposable income and confidence, they posed mixed risks to household consumption – anticipated to witness markedly weaker dynamics in 2020 Q4 or even a contraction in annual terms, before re-embarking on a firm recovery trend and returning to significantly positive readings in 2021.


Heightened uncertainties also surrounded the future evolution of investment, whose growth was expected to moderate in 2020 Q4, but to remain positive during the year overall – underpinned inter alia by government programmes and measures –, before regaining slight momentum in 2021. It was shown that the outlook was, nevertheless, conditional on consumer demand and external demand, implicitly on the functioning of global production chains, but also on corporate income/profits and investor confidence, as well as on the speed of recovery of the home countries of foreign investment – all potentially hit for longer by the resurgence of the pandemic.


At the same time, Board members underlined that a sizeable absorption – starting 2021 – of European funds allocated to Romania via the EU-agreed economic recovery package and multiannual budget would likely boost investment even beyond expectations. Over the longer term, investment growth could also be spurred by possible relocations to Romania of European companies’ production facilities from other continents – conditional, however, on domestic improvements in infrastructure, legal framework predictability and digitalisation of the economy.


Board members discussed at length about public finances and the high uncertainty associated with the related outlook, also in the electoral context, conducive to risks to macroeconomic developments and stability over a longer time horizon.


Concerns were voiced about the sizeable, possibly above-expectations, increase in the 2020 budget deficit, under the impact of the pandemic crisis and the adopted support measures, as well as a result of the rise in some permanent expenditures, with knock-on effects on future budget executions, as well as on financing needs and costs. In that context, the start in the near future of the necessary budget consolidation was deemed, however, as highly possible, conducive in turn to risks to the current macroeconomic forecast, inter alia via the features and stages of budget adjustment measures.


It was again advocated in favour of their being focused on current expenditure, in order to minimise adverse effects on the recovery and the growth potential of the economy in the medium term, as well as to prevent the external imbalance from worsening.


The economy’s external position was considered a matter of concern as well, in view of the further widening in 2020 of the trade deficit as a share of GDP, as well as the worsening of its financing structure, amid the severe contraction in foreign direct investment, with implications for external debt dynamics. Furthermore, mention was made of the considerable risks to euro area economies, and hence to external demand, posed by the new pandemic wave and by the increasingly restrictive measures taken; at the same time, reference was made to the robust, above-expectations recovery of economic activity both globally and in Europe immediately after the marked downturn in 2020 Q2.


In the Board members’ unanimous opinion, the analysed context warranted leaving unchanged the monetary policy rate and the interest rates on the NBR’s standing facilities. Such a calibration of the monetary policy conduct was likely to provide an underpinning to the recovery of economic activity over the projection horizon, with a view to bringing and strengthening over the medium term the annual inflation rate in line with the 2.5 percent ±1 percentage point inflation target, while safeguarding financial stability.


Under the circumstances, the NBR Board unanimously decided to keep the monetary policy rate at 1.50 percent; it also decided to leave unchanged the deposit facility rate at 1.00 percent and the lending (Lombard) facility rate at 2.00 percent. Moreover, the NBR Board unanimously decided to maintain the minimum reserve requirement ratio on leu-denominated liabilities at 8 percent.


Given the developments in foreign currency lending and the adequate level of forex reserves, the NBR Board unanimously decided to cut the minimum reserve requirement ratio on foreign currency-denominated liabilities of credit institutions to 5 percent from 6 percent starting with the 24 November – 23 December 2020 maintenance period.


The measure also aimed to continue the harmonisation of the minimum reserve requirements mechanism with the relevant standards and practices of the European Central Bank and the major central banks across the European Union.