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Minutes of the monetary policy meeting of the National Bank of Romania Board on 15 May 2019

22 May 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; 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 the recent characteristics and the updated forecast of medium-term macroeconomic developments submitted by the specialised departments, as well as on other available domestic and external information.

Looking at the recent inflation developments, Board members emphasised that the annual inflation rate had recently continued to climb above the variation band of the target, from 3.83 percent in February to 4.03 percent in March and to 4.11 percent in April, i.e. significantly above the forecast. It was noted that, during the first months of 2019, the annual inflation rate had markedly moved in the opposite direction of the forecasts and that all major CPI components had posted higher-than-expected monthly increases. The drivers behind the re-acceleration of inflation had been the developments in the prices of vegetables and fruit, the prices of tobacco products and fuels, as well as the dynamics of core inflation.

It was remarked that the annual adjusted CORE2 inflation rate had gone up visibly faster than expected – to reach 3 percent in April from 2.4 percent in December 2018 – and that its rise had been supported during that period by all sub-components and especially the growth rate of services prices, largely reflecting the influences of a weaker leu against the euro and the impact of the new tax levied on the telecom sector.

According to several Board members, the overall developments in core inflation further reflected demand-pull and wage cost-push inflationary pressures, in line with the cyclical position of the economy and with the faster growth rate of private consumption in 2018 Q4 – likely persisting into 2019 Q1 –, as well as with the strong increase in the annual dynamics of unit wage costs in industry in the first months of 2019. It was deemed that the slightly upward trend followed in Q1 by the annual dynamics of industrial producer prices on the domestic market for consumer goods also sent signals indicative of inflationary pressures in the economy, alongside the notably upward revision of the GDP deflator for 2018 Q4 and the recent significant adjustment to the upside of short-term inflation expectations. Some Board members underlined that labour market tensions favoured the rise in unit labour costs and, implicitly, inflationary pressures, also noting that the phenomenon was broad-based across emerging economies in Central and Eastern Europe.

As for the cyclical position of the economy, Board members noted that the second provisional version of statistical data reconfirmed the 4.1 percent economic advance in annual terms in 2018 Q4, yet amid a more modest slowdown in the quarterly dynamics, implying a somewhat wider increase of the positive output gap in that period than that anticipated in the February forecast. Board members looked at the main revisions of GDP components and their implications, underlining the drop in the contribution of household consumption and the rise in that of the change in inventories, with the latter thus remaining the main driver of economic expansion for the third quarter in a row. Discussions also touched upon the unchanged negative contribution of gross fixed capital formation to economic growth and the lower negative contribution of net exports, in the context of a more pronounced upward revision of the growth rate of exports of goods and services compared to that of imports, with both thus gaining momentum versus Q3. According to the incoming data, the deficit on trade in goods and services had continued to grow markedly in annual terms in 2018 Q4, the same as the current account deficit.

It was remarked that the 4.1 percent economic growth previously estimated for 2018 was reconfirmed, but, in light of the new data, its main driver was the change in inventories, ahead of household consumption, with a contribution revised downwards, whereas gross fixed capital formation and net exports eroded economic expansion. Stress was once again put on the pick-up in the current account deficit to 4.5 percent of GDP in 2018 from 3.2 percent in 2017, concurrently with the decline in its coverage by autonomous capital flows.

Board members agreed that, based on the new data and assessments, a robust economic growth in annual terms was also expected in the first half of 2019, amid some mild fluctuations in the quarterly growth, so that the positive output gap would likely grow in that period in line with the February forecast. The uncertainties about the new fiscal and budgetary measures and the implications for aggregate demand and potential GDP were, however, reiterated.

It was noted that the developments in high-frequency indicators showed private consumption as the engine of economic growth in 2019 Q1, also suggesting an improvement in the impact of the gross fixed capital formation. By contrast, the negative contribution of net exports may have risen, given the strong acceleration of the annual growth of trade deficit in the first three months of the year, amid a more pronounced slowdown in the dynamics of exports of goods and services than in those of imports. The further widening, in that context, of the current account deficit from the same period of the previous year was viewed as worrisome by some Board members.

Discussions touched again on labour market tightness, whose upward trend had probably continued into 2019 Q1 – after the post-crisis peak reached in the previous quarter –, given that the unemployment rate had fallen in February and had remained at a new historical low in March, while the number of employees economy-wide had touched new highs. Mention was also made of companies’ hiring intentions for the near future as pointed out by the latest surveys, as well as of the limited capacity on that horizon of remedial measures to solve the structural problems of the market, such as the shortfall of skilled personnel and the skill mismatch. It was deemed that, against that background, pressures on wages would remain high, also considering the new significant hikes in the gross minimum wage economy-wide and public sector wages. It was noted that in 2019 Q1 the annual dynamics of average gross nominal wage earnings had reached a second post-2009 peak, while the annual growth rate of the average net real wage earnings had returned to a two-digit range, the same as the annual change of unit wage costs in industry, which had almost doubled against the previous quarter.

Relative to monetary conditions, Board members pointed out the increase seen in April by the main ROBOR rates – and hence by their positive spread vis-à-vis the monetary policy rate –, as well as the relatively steeper upward path of the interest rate on interbank money market transactions, followed however by a downward adjustment in May, even amid the central bank’s control over money market liquidity via time deposit-taking operations. Reference was also made to the decline witnessed in March by the average interest rate on non-financial corporations’ new time deposits and to the standstill of that on households’ similar deposits – deemed as unfavourable to saving –, as well as to the significant slowdown in the same month of the advance in the average lending rate on new business. Attention was drawn to the high uncertainties generated in that context by the coming into force, as of 2 May, of the 2.36 percent level of the new benchmark index for consumer loans (IRCC) – calculated based on 2018 Q4 data and applicable in 2019 Q2 –, discussions also touching on the implications of this change for the monetary policy transmission and stance and, ultimately, for the entire policy framework. The recent relative stabilisation of the EUR/RON exchange rate was underlined, but in the context of the further deterioration of the external position of the economy, its future evolution was considered to remain a source of concern from the perspective of inflation and confidence in the domestic currency, especially in the event of a sudden change in the global financial market sentiment and/or a swing in the risk perception vis-à-vis the local economy/financial market.

It was observed that the annual growth rate of credit to the private sector had continued to decelerate slightly in March, but had remained robust (7.7 percent). The impact of the slower rise in the domestic currency component – visible mainly for consumer loans and primarily ascribable to some base effects – had largely been counterbalanced by that of the slacker decline in the foreign currency component, alongside the statistical effect of the increase in the EUR/RON exchange rate. The share of the leu-denominated component in total private sector credit had widened to 65.8 percent.

As for future developments, Board members showed that the annual inflation rate would probably remain above the variation band of the target in 2019, exceeding the previously anticipated levels, before returning to, but also staying in the upper half of the band, at slightly higher values than in the forecast published in the February 2019 Inflation Report. Specifically, it was expected to reach 4.2 percent in December 2019 and 3.4 percent at the end of the projection horizon, compared with the previously forecasted levels of 3.0 percent and 3.1 percent respectively.

It was noted that the relative worsening of the short-term inflation outlook was mainly attributable to the action of supply-side factors, which, contrary to earlier forecasts, had turned inflationary again and would probably remain so in 2019. That had owed largely to developments in the prices of vegetables, fruit, eggs, tobacco and fuels, but also to the one-off impact of the new tax on the telecom sector. Against that background, some Board members pointed out the temporary nature of the annual inflation rate running above the upper bound of the variation band of the target, mentioning the disinflationary base effects that would be manifest in the early months of 2020 – associated with the recent adverse supply-side shocks –, but also possible corrections in vegetable and fruit prices. It was agreed that the outlook for the exogenous CPI components remained, however, highly uncertain in the current context and that larger-than-expected increases were possible, especially in the case of administered prices and in the prices of some agri-food items and fuels – sensitive to movements in international prices.

Moreover, it was shown that inflationary pressures from fundamentals were expected to grow progressively across the forecast horizon, and even slightly more visibly in the longer run than previously projected. They were seen having as probable sources the cyclical position of the economy, the upward adjustment of short-term inflation expectations and the sustained increase in wage costs, as well as the faster dynamics of import prices, inter alia due to the evolution of the leu exchange rate. Against that backdrop, but also following the impact of the new tax on telephony and radio-TV subscription prices, the annual adjusted CORE2 inflation rate was expected to climb in the first four quarters significantly above the previously-forecasted values and even above the variation band of the target, i.e. to 3.8 percent in December 2019 against 3.3 percent in the earlier projection. Subsequently, it was foreseen to return to and remain marginally below or at the upper bound of the band, slightly higher than previously anticipated.

As regards the prospects for the cyclical position of the economy, Board members observed that, similarly to the previous forecast, the annual pace of economic growth was expected to decelerate in 2019 and 2020, but at the same time to remain significantly and then marginally above the potential rate. The latter was anticipated to be affected, in turn, by the recently implemented measures, as well as by the previous decline in investment, overlapping the persistent structural deficiencies of the economy. The outlook implied that excess aggregate demand would rise and thereafter stick to values comparable to those in the prior forecast.

According to Board members’ assessment, private consumption would consolidate its role of quasi-single driver of economic growth, under the stimulative impact of the higher real disposable income, due to wage increases – possibly even above expectations, given the tight labour market conditions –, as well as to the rise in social transfers. Conversely, despite the recent revival in construction and EU funds absorption, an obvious rebound in investment was deemed improbable, given the constraints from the configuration of the budget programme, as well as from the frequent legislative measures and changes in recent years likely to weigh on companies’ profits and confidence, but also on the dynamics of foreign direct investment. Furthermore, the future fiscal and income policy stance was further surrounded by elevated uncertainties.

The prospects for a further deterioration of net exports and hence of the current account were considered worrying, likely to pose risks to inflation, via the exchange rate, but also to economic growth sustainability. Board members reiterated that the current external imbalance – singular in the region in terms of size and trend – owed to the faster dynamics of domestic absorption than those of domestic output, as well as to non-price competitiveness issues of the Romanian economy manifest in certain production sectors. Some Board members underlined that an orderly correction of that imbalance called for a budget adjustment, alongside structural reforms, which however required time.

It was observed that the outlook for net exports reflected a weakening of external demand as well, amid a more pronounced deceleration in euro area/EU economic growth implied by the current forecast, mention being also made of the heightened risks induced by the trade war, but also of the faster-than-expected advance seen in 2019 Q1 by the major economies, the euro area one included. Reference was also made to the probable monetary policy conduct of the ECB and of other major central banks, as well as to the stance of central banks in the region, also in the context of discussing the assumption on gradually less accommodative monetary conditions, incorporated in the updated projection. Some Board members noted that strong inflationary pressures were manifest in other economies in the region as well, due to labour shortage, but that the external balances of those economies were more favourable than in the case of Romania.

In the same context, the importance of an adequate dosage and pace of adjustment of the monetary policy stance was reiterated, with a view to anchoring inflation expectations and bringing the annual inflation rate back into line with the inflation target, while safeguarding financial stability. Moreover, Board members underlined the need for a balanced macroeconomic policy mix to avoid the overburdening of monetary policy, with undesired effects in the economy; a balanced policy mix was also necessary for the orderly adjustment of the current account deficit. At the same time, it was deemed that, given the macroeconomic conditions and the domestic and external risks, a tightened 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 tightening 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.