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Minutes of the monetary policy meeting of the National Bank of Romania Board on 5 August 2022

19 August 2022

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; Leonardo Badea, Board member and Deputy Governor of the National Bank of Romania; Eugen Nicolaescu, 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 Rusanu, 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.


Looking at the recent inflation developments, Board members showed that the annual inflation rate had increased at a slower pace in June, as anticipated, seeing however, in 2022 Q2 as a whole, a considerably stronger rise than in the previous quarters and above expectations, namely to 15.05 percent in June, from 10.15 percent in March, given the changes made in April to the capping schemes for households’ energy bills.


Specifically, most of the increase had come again from exogenous CPI components, primarily from the hefty and larger-than-anticipated hikes in electricity and natural gas prices – inter alia, due to the further high international prices –, alongside the more subdued influences from fuel prices, under the impact of the advance in the crude oil price, amid the war in Ukraine and the associated sanctions, but also due to the US dollar strengthening against the euro.


At the same time, the annual adjusted CORE2 inflation rate had further witnessed a steeper upward path in 2022 Q2, climbing from 7.1 percent in March to 9.8 percent in June, slightly above the forecast, given that the contribution of the processed food sub-component to that advance had reached a quarterly peak of the past year, under the impact of the hikes in international commodity prices as well as higher energy and transport costs, Board members pointed out. By contrast, the contribution from the services sub-component had dropped to the lowest quarterly level in 12 months – probably reflecting inter alia the evolution in annual terms of the EUR/RON exchange rate –, while the contribution of the non-food sub-component had diminished slightly.

Following the analysis, Board members agreed that the faster increase in the annual adjusted CORE2 inflation rate during that period was still ascribable to global supply-side shocks, amplified and protracted by the war in Ukraine and the associated sanctions. Their direct and indirect inflationary effects had continued to be compounded domestically by the high short-term inflation expectations, the release of previously pent-up demand in certain segments, as well as by the significant share of food items and imported goods in the CPI basket. Several Board members underlined yet again the global magnitude of the broad-based inflation caused by global supply-side shocks, referring to the record-highs over the last decades touched by annual inflation rates in developed economies, including in many European countries.


At the same time, they emphasised the larger increase seen in April-May by the growth rates of industrial producer prices on the domestic market, including the consumer goods segment – under the influence of higher costs of energy and other commodities, especially agri-food items, as well as amid persistent bottlenecks in production and supply chains –, likely to continue to pass through in the near future into the prices of some consumer goods and services, but also depending on demand conditions.


Members also stressed the economic agents’ high and rising short-term inflation expectations at end-Q2, but also the relative levelling-off of financial analysts’ longer-term inflation expectations, as well as the more obvious erosion trend of the consumer purchasing power, reflected in the dynamics of the average real net wage returning deeper into negative territory in April-May.


As for the cyclical position of the economy, Board members observed that the new provisional version of statistical data on GDP developments had reconfirmed the strong economic growth in 2022 Q1, i.e. 5.1 percent against 2021 Q4. That implied a higher-than-expected resurgence in positive output gap in the same period, albeit relatively moderate, given, inter alia, the implications of the recent revision of statistical data on quarterly GDP growth rates.


Moreover, the substantial step-up in the annual GDP dynamics in 2022 Q1 – to 6.4 percent from 2.4 percent in 2021 Q4 – had been reconfirmed. While a significant contribution had been made by the change in inventories, the main contribution had come from private consumption, attributable however to other sub-components than purchases of goods and services, which had reported a markedly lower increase in annual terms in that period, inter alia amid a base effect.


A notable positive contribution to the swifter pace of increase had also been made by gross fixed capital formation, while net exports had further acted towards improving economic growth – their contribution to annual GDP dynamics re-entering positive territory for the first time in the past five years –, as the rise in the annual change in the export volume of goods and services had outpaced that in the import volume.

However, the annual increase in the negative trade balance had re-accelerated, primarily amid the relatively more unfavourable developments in import prices, while the current account deficit had seen 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.


As for the near-term outlook, Board members agreed that economic activity was likely to post a quasi-standstill compared with 2022 Q1, under the impact of the war in Ukraine and the associated sanctions. The developments implied a contraction in excess aggregate demand during that period – which was seen, however, following a noticeably higher path than had been expected in May – as well as a decline in the annual dynamics of GDP in Q2, from the particularly high level reached in 2022 Q1.


It was noted that the latest high-frequency indicators showed, however, the further step-up in the annual increase in private consumption in Q2, chiefly on account of a base effect, while significant opposite influences on the annual GDP growth rate had probably come from gross fixed capital formation but also from net exports, given the divergence recorded in April-May 2022 between the rise in the annual change in imports and the decrease in that of exports of goods and services, only partly ascribable to the adverse developments in external prices.


Against that background, the swift annual dynamics of trade deficit had picked up substantially as compared with the Q1 average, whereas the current account deficit had continued to widen, albeit at a slower pace, posting a lower annual advance than in the first three months of the year, amid the improved income balances. Although partly attributable to incidental factors, the trends were viewed as particularly worrisome by Board members, given also the increasingly pronounced drop against end-2021 in the coverage of the current account deficit by foreign direct investment and capital transfers.


Looking at labour market developments, Board members showed that the number of employees economy-wide had seen new marked rises in April and May, almost entirely on account of hiring in the private sector, while the ILO unemployment rate had continued to fall in the second quarter, remaining however above pre-pandemic levels at end-Q2, i.e. at 5.3 percent. At the same time, average gross nominal wage had further recorded a faster, two-digit annual growth rate in the first two months of Q2, without matching, however, the inflation rate, and the high annual dynamics of the unit labour cost in industry had picked up even faster, albeit amid large monthly swings.


That development was viewed as worrisome by some Board members, in spite of its being widely attributed to the marked annual decline in labour productivity in the first months of the year, on the back of bottlenecks in production chains and elevated energy and commodity costs. In addition, reference was made to the recent measures on the hike in the gross minimum wage in certain sectors and the wage increases in the public sector pending enactment into law, but also to the high inflation rate, likely to speed up the dynamics of some wages in the near future.


Nevertheless, the labour shortage reported by companies had witnessed a small setback at the beginning of H2, after the steady upward trend over the past almost two years, several Board members remarked, while the hiring intentions for the near-term horizon had declined somewhat, in the context of mixed sectoral developments, probably explained by the effects and uncertainties generated by the protraction of the war in Ukraine and the expansion of the associated sanctions, with an impact on demand too. At that juncture, the constraints on firms resulting from high energy, transportation and commodity costs continued to be an additional factor slowing down the broad-based uptrend in wages, some Board members deemed.


At the same time, it was assessed that, beyond the near-term horizon, the ability of some businesses to remain viable/profitable in the context of high costs would be challenged also by the cessation of government support measures, as well as by the need for technology integration, possibly leading to restructuring or bankruptcy of firms. Notable uncertainties regarding future labour market conditions also stemmed from the expansion of automation and digitalisation domestically, alongside a higher resort to workers from outside the EU.


Turning to financial market conditions, Board members pointed out that the main interbank money market rates had risen at a faster pace in the recent period, prompted by the monetary policy rate hike in July and the central bank’s firm control over market liquidity. It was agreed that an important part in that process had also been played by credit institutions’ expectations, in the context of the domestic and international inflationary environment, as well as of the protraction in geopolitical tensions.


The yields on government securities had posted, however, a slower advance, thereafter witnessing downward adjustments, in line with developments in global bond markets, amid the revision of investors’ expectations on the economic growth outlook, in response to the faster normalisation of the monetary policy conduct by the Fed and the ECB, but also to the protraction of the war in Ukraine and the extension of the associated sanctions. Conversely, under the influence of interbank money market developments, the average interest rate on new time deposits had seen a a faster rise than both that of the average lending rate on new business – the spread between them hitting again a historical low in June – and the increases in the region, with positive effects on savings, several Board members deemed.


At that juncture – reflecting also a higher relative attractiveness of investments in domestic currency, inter alia amid the narrower short-term rate differential as a result of the central banks in the region having slowed/halted the key rate hikes –, but also due to seasonal factors, the leu had posted a slight appreciation trend versus the euro in July, with favourable implications for inflation and confidence in the national currency, Board members noted. Risks to the behaviour of the EUR/RON exchange rate – likely to also affect external vulnerability indicators – continued to come from the widening external imbalance and the uncertainties surrounding budget consolidation, as well as from a possible further worsening of the risk perception associated with financial markets in the region, amid the protraction of the war in Ukraine, some Board members warned.


At the same time, it was noted that the annual dynamics of credit to the private sector had picked up further in June, reaching 17.5 percent, yet against the backdrop of a mild moderation in domestic currency lending, whose impact had been counterbalanced by the considerable step-up in the growth of foreign-currency denominated loans to non-financial corporations. The share of leu-denominated loans in credit to the private sector had fallen slightly to 72 percent, from 72.7 percent in May.


As for future macroeconomic developments, Board members showed that the most recent assessments revealed the outlook for the annual inflation rate to level off in 2022 Q3 and gradually decline later on, yet on a path revised moderately upwards. Specifically, the annual inflation rate was expected to post minor fluctuations in Q3, and then enter a gradual downward path for three quarters, but relatively fast afterwards, to reach 13.9 percent in December 2022 – markedly above both the variation band of the target and the previously forecasted 12.5 percent value –, before falling to 2.3 percent at the end of the projection horizon, slightly below the mid-point of the target.


It was noted that the prospects for the annual inflation rate to level off and subsequently reverse its path relied chiefly on milder direct and indirect effects of global supply-side shocks – in the context, inter alia, of energy price capping schemes implemented until March 2023 – as well as on the disinflationary base effects associated with the steep hikes recorded since the latter part of 2021 by energy, fuel and processed food prices, together with influences from the likely downward adjustment of some commodity prices, amid the easing of wholesale markets.


However, the projected path of the annual inflation rate was revised moderately upwards, mainly due to the relatively higher dynamics anticipated for fuel, energy and processed food prices, prompted by the higher-than-expected international prices seen in the recent period, the Board members deemed. Moreover, it was pointed out that the hefty inflationary effects of energy commodity prices would become strongly manifest once the price capping schemes were to be discontinued in April 2023, entailing a temporary reversal of the decline in the annual inflation rate, which would resume, nonetheless, thereafter and deepen at mid-2023 and then in April 2024.


At the same time, it was agreed that the impact presumed to be exerted by energy and fuel price capping and compensation schemes continued to be marked by high uncertainty. Furthermore, the overall balance of supply-side risks to the inflation outlook remained tilted to the upside, at least in the short run, amid the war in Ukraine and the associated sanctions – with potential more severe implications for energy commodity prices as well as for production and supply chains –, but also amid the protracted drought domestically and in other European countries. Uncertainty was related, however, to the duration of support schemes, which could be extended beyond the date provided by the regulations in force, some Board members argued.


Nevertheless, underlying pressures would see their mildly inflationary impact fade out relatively quickly and become disinflationary starting 2023 Q3, Board members concluded, given the prospects for economic growth to slow considerably in the latter part of 2022 and somewhat more moderately in 2023, also compared to previous forecasts, making excess aggregate demand likely to decline swiftly and come down to zero at mid-2023 – a few quarters earlier than projected previously –, followed by a gradual deepening of the output gap in negative territory.


In the near future, Board members remarked that core inflation dynamics would however continue to be affected by inflationary effects from supply-side shocks, particularly those stemming from the hike in agri-food commodity prices, which would be further compounded by high short-term inflation expectations and by the significant share of processed foods and imports in the core inflation basket.


Under the circumstances, the annual adjusted CORE2 inflation rate would probably continue to increase until end-2022, although at a much slower pace, climbing to 11.4 percent in December, very slightly above the previously-anticipated level. Afterwards, it would embark on a somewhat slower downward trend than forecasted earlier and decline at the end of the projection horizon to 3.8 percent, below the May forecast of 4.2 percent.


Looking at the future cyclical position of the economy, Board members observed that the economic activity forecast had been revised considerably upwards for 2022, yet solely as a result of GDP growth way above expectations in Q1, whereas that for 2023 had been revised significantly downwards, amid the stronger adverse impact presumed to be exerted by the war in Ukraine and the sanctions imposed, only partly counterbalanced by the effects from the absorption of EU funds under the Next Generation EU instrument. The evolution implied a turnaround in the output gap pattern. Specifically, after having seen a higher-than-expected resurgence in its positive value in 2022 Q1, the output gap was envisaged to narrow relatively quickly and gradually fall into negative territory starting in 2023 Q3.


It was noted that private consumption would probably remain the major driver of GDP advance, given its significantly faster increase in 2022 – almost entirely attributable to the unexpectedly robust step-up in Q1 –, followed however by a steep loss of momentum in 2023, inter alia under the influence of the gradual rise in lending and deposit rates for households.


By contrast, gross fixed capital formation was envisaged to see its growth accelerate only slightly in 2022, but considerably in the following year, amid the abatement of the war’s effects, Board members showed. Relevant from that perspective were deemed the heightened uncertainties and the effects generated in the short run by the protraction of the war in Ukraine and the extension of the associated sanctions – especially via the softening of external demand, the persistence of bottlenecks in production chains, and the tightening of financing conditions –, but also the probable increase in public capital expenditure, potentially in the energy and transport sectors as well, inter alia with a contribution from EU funds, with stimulative effects on the private sector.


Net exports, however, would probably make a notable negative contribution to the GDP dynamics in 2022 as well – against the background of a pronounced deceleration in the EU’s economic growth and the strong rise in commodity prices – and have a neutral effect in 2023, amid a slower advance in imports, in correlation with the evolution of domestic absorption. As a result, the current account deficit was expected to widen further as a share of GDP in 2022, inter alia under the influence of the further deterioration of developments in import prices as compared to those in export prices, before shrinking only slightly the following year. Board members viewed those developments as worrisome, particularly in terms of potential adverse implications for inflation, the sovereign risk premium and, ultimately, for economic growth sustainability.


At the same time, it was repeatedly shown that the war in Ukraine and the associated sanctions further generated 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.


Moreover, the absorption of EU funds, especially those under the Next Generation EU programme, was conditional on fulfilling strict milestones and targets for implementing the approved projects, Board members repeatedly underlined. However, the absorption of those funds was essential for carrying out the necessary structural reforms, energy transition included, as well as for counterbalancing, at least in part, the contractionary impact of supply-side shocks, compounded by the war in Ukraine. It was vital to absorb and reap the full benefits of these funds at the current juncture, according to several Board members.


Major uncertainties and risks were, however, associated with the fiscal policy stance as well, Board members agreed. They referred to the budget execution in 2022 H1 and the requirement for further fiscal consolidation amid the excessive deficit procedure and the overall tightening trend of financing conditions.


At the same time, they highlighted primarily the current challenging economic and social environment domestically and globally, as well as the packages of support measures for households and firms, with potential adverse implications for budget parameters. From that perspective, the coordinates of the envisaged budgetary revision were particularly important.


Most of the Board members deemed that the reviewed context overall warranted a 0.75 percentage point increase in the monetary policy rate, so as to anchor inflation expectations over the medium term and to foster saving, with a view to bringing 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.


They underlined again the importance of the dosage of measures and of the calibration of the monetary policy conduct at the current juncture to avoid, as much as possible, a significant slowdown of economic growth, given also the major contractionary effects generated by the sizeable supply-side shocks, the energy crisis in particular, but also the requirement for fiscal consolidation progress.


A 1.00 percentage point rate hike was also discussed, the main reasons cited being the elevated annual inflation rate and the moderately upward revision of the anticipated inflation path, as well as the recent monetary policy decisions made by major central banks, alongside the calendar of monetary policy meetings of the NBR Board implying a relatively higher time lag between the current and the next policy meeting. Some members leaned towards that action.


At the same time, Board members unanimously advocated the need to maintain firm control over money market liquidity and they reiterated the importance of further closely monitoring domestic and global developments so as to enable the NBR to tailor its available instruments in order to achieve the overriding objective regarding medium-term price stability.


Under the circumstances, the NBR Board decided with a majority of votes, i.e. 6 for and 3 against, to increase the monetary policy rate to 5.50 percent from 4.75 percent as well as to raise the lending (Lombard) facility rate to 6.50 percent from 5.75 percent and the deposit facility rate to 4.50 percent from 3.75 percent. Three members voted for a policy rate hike to 5.75 percent.


At the same time, the NBR Board unanimously decided to maintain firm control over money market liquidity. In addition, the NBR Board unanimously decided to keep the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions.