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Minutes of the monetary policy meeting of the National Bank of Romania Board on 8 January 2020

15 January 2020

The National Bank of Romania Board members present at the meeting: 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; 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 developments in consumer prices, Board members showed that, in October, the annual inflation rate had declined to 3.4 percent from 3.5 percent in September, while in November it had risen again above the variation band of the target to 3.8 percent, in line with the forecast. It was noted that the advance against September had owed mainly to the hike in fruit and vegetable prices, but also to the pick-up in core inflation and that the relatively modest impact of the increase in fuel prices had been fully offset by that of the slowdown in the dynamics of administered prices.

The annual adjusted CORE2 inflation rate had posted a slightly faster rise during that period, climbing from 3.4 percent in September to 3.5 percent in November, marginally above the forecast, even amid the mild disinflation in the non-food segment, probably on account of November sales. Also in that context, it was deemed that, apart from the effects of higher global agri-food commodity prices, especially for pork meat, and of the slightly softer leu versus the euro, the evolution of core inflation had showed significant inflationary pressures from fundamentals, in line with the size, trend and determinants of the cyclical position of the economy, as well as with labour cost dynamics. Such pressures had also been hinted at by the recent consolidation of the upward movement in the annual change of producer prices for consumer goods on the domestic market, as well as by the further elevated GDP deflator in 2019 Q3, similar to that in the previous period, alongside the high or even rising – in the case of some economic agents – short-term inflation expectations over the last months.

As for the cyclical position of the economy, Board members remarked that in 2019 Q3 the economic growth had seen a somewhat faster-than-expected deceleration to 3.0 percent from 4.4 percent in Q2, yet amid a minor slowing, markedly below expectations, in its quarterly dynamics, ascribable to the contraction in agricultural output. It was deemed that the developments suggested a continued upward trend of excess aggregate demand, contrary to the expectations of a temporary halt in that trend in the first half of 2019 H2. Moreover, the contribution of private consumption to the economic advance had remained significant, in spite of a visible fall, with the deceleration in its growth rate owing entirely to sub-components sensitive to agricultural performance, such as self-consumption, whereas retail purchases of goods and services had seen a reacceleration of their annual growth rate. The contribution of gross fixed capital formation had considerably exceeded that of household consumption, as some members pointed out, reaching an 11-year high, mainly on account of investment in new construction works, as well as of the faster pick-up in equipment purchases, with a favourable impact on the economy’s future growth potential. By contrast, net exports had resumed the widening trend in their negative contribution to economic growth amid a more pronounced reacceleration in the growth of imports relative to that of exports of goods and services, also visible in the swifter annual dynamics of the negative balance on trade. At the same time, the current account deficit had continued to widen in annual terms, albeit at a slower pace, while its coverage by foreign direct investment and capital transfers had narrowed further. The trends were viewed as particularly worrisome by some Board members, inter alia in the context in which the weakening of exports had also coupled with a faster decline in industrial production, mainly on the back of the automotive segment, carrying the potential to increase the negative contribution of that sector to GDP dynamics, on the supply side.

Board members continued to voice concerns over labour market tightness too, citing the large labour shortage facing certain market segments – compounded by structural problems – alongside the mounting difficulties encountered by employers in the recruitment process, increasingly mentioned by companies as well. At the same time, they observed that the job vacancy rate had ceased to decrease in 2019 Q3, whereas the ILO unemployment rate had remained near the historical low seen at end-Q2, posting only a marginal rise. Furthermore, the number of employees economy-wide had continued its slow uptrend resumed in mid-2019, and its annual dynamics had regained slight momentum in October, for the first time in almost three years, given that the faster downsizing in industry – attributable, inter alia, to automation and other structural changes – had been more than offset by the step-up in hiring in other sectors, such as construction. Reflecting those developments, the annual growth rate of average gross nominal wage earnings, as well as that of net real wage earnings, had stuck to two-digit readings during the last months, while the two-digit annual change in the unit wage cost in industry had even continued to expand, in the context of a sharper deterioration of labour productivity, weighing on the competitiveness of some industrial sub-sectors. It was deemed that wage pressures would remain elevated in the near run, given, inter alia, the clear improvement in employment intentions for the first months of 2020, shown by surveys, as well as the new hikes in the gross minimum wage economy-wide and public sector wages in early 2020.

Looking at monetary conditions, Board members showed that the main ROBOR rates had seen their slow downtrend come to a halt in November, before posting an increase in December 2019, amid the relative temporary tightening of liquidity conditions, as well as the steady mopping up by the NBR of excess liquidity on the money market through deposit-taking operations. Against that backdrop, the interest rates on interbank transactions had also climbed and remained slightly above the policy rate in December, their quarterly average thus widening marginally versus that in Q3; implicitly, its negative spread vis-à-vis the monetary policy rate and that versus the 2.66 percent benchmark index for loans to consumers (IRCC) in Q4 had narrowed slightly. The average interest rate on new loans had however decreased in October-November entirely on account of consumer credit, mainly fixed-rate consumer loans. Although possibly incidental, the evolution was likely to heighten the uncertainty generated by the IRCC from the perspective of the monetary policy transmission and conduct, according to some Board members, inter alia in the context in which at the start of 2020 Q1 the level of that indicator had fallen to 2.36 percent.

Mention was also made of the uptrend of the EUR/RON exchange rate in 2019 Q4, primarily half way through the quarter – relatively at odds with the trend prevailing across the region –, which had however nearly halted towards year-end, amid the considerable interest rate differential, the improvement in global financial market sentiment, and the decisions/expectations on the persistence of the accommodative monetary policy stance of the ECB and the Fed, as well as of the conduct of central banks in the region. Nevertheless, some Board members drew attention to the fact that, in the context of the twin deficits, a renewed increase in pressures on the exchange rate was highly possible, especially in the event of a sudden change in global market sentiment or of a repricing of risk associated by investors with the local economy/financial market, which called on the central bank to remain alert.

Board members also pointed to the robust, only slightly slower, growth further witnessed by credit to the private sector October through November, its average dynamics for the period as a whole declining to 7.3 percent versus 7.9 percent in Q3, but remaining visibly above the 2018 reading. Moreover, reference was made to the widening of the share of domestic currency loans in total private sector credit to a post-May 1996 high of 67.2 percent in November, as the growth rate of that component had remained constant in the vicinity of two-digit levels, inter alia with the contribution of loans to non-financial corporations.

As for future developments, Board members showed that, after having stayed above the variation band of the target at end-2019, the annual inflation rate would probably fall comfortably in the upper half of the band in the early months of 2020, to slightly lower values than in the medium-term forecast published in the November 2019 Inflation Report, which had seen it at 3.1 percent in December 2020 and 3.2 percent at the end of the forecast horizon. It was remarked that the expected downward correction would be entirely attributable to the action of supply-side factors. The correction would be mainly driven by foreseeable disinflationary base effects associated with developments in exogenous CPI components and the tax levied on the telecom sector, while its relative steepening would owe primarily to the more pronounced deceleration in the anticipated fuel price dynamics, as a result of removing the special excise duty on motor fuels in January 2020. Several members warned that the oil price outlook was, however, marked by heightened uncertainties, with related upside risks stemming, at least in the near run, from the recent escalation of geopolitical tensions. It was deemed that larger-than-expected increases were also possible for some processed food prices – amid the spread of the African swine fever and movements in some agri-food commodity prices –, but also in the case of administered prices, in the event of the liberalisation of natural gas and electricity markets in the not too distant future, implying costlier utilities for household consumers.

Furthermore, it was agreed that the action of fundamentals would probably be slightly more inflationary over the short-time horizon than previously envisaged, owing mainly to the somewhat stronger pressures expected to be exerted by aggregate demand, given the anticipated relative pick-up in economic growth during 2019 Q4 and 2020 Q1 overall, including as compared to the previous projection. In the Board members’ assessment, such an outlook implied a quasi-standstill of the positive output gap in that period at the relatively higher value reached in 2019 Q3, i.e. slightly above the levels forecasted in November. Moreover, according to the latest high-frequency indicators, the contribution of household consumption to GDP growth may have risen in 2019 Q4 at least on par with that of gross fixed capital formation, and the negative contribution of net exports may also have declined, given the slower increase in annual terms of the trade deficit in October, amid new relatively similar losses of momentum posted by exports and imports of goods and services. Some Board members observed that the current account deficit had, however, resumed its year-on-year widening trend, while its coverage by autonomous capital flows had continued to deteriorate.

The uncertainties stemming in the current context from the fiscal and income policy stance, as well as the risks thus induced to the latest medium-term forecast, were however particularly high, Board members repeatedly underlined. Reference was made to the looser-than-expected budget execution in the closing months of 2019 – warranted also by some expenditures whose postponement would have generated a chain accumulation of arrears –, implying a probable increase in the budget deficit way above the 3 percent-of-GDP ceiling set under the Stability and Growth Pact, worrisome inter alia in terms of domestic and external financing costs. At the same time, it was deemed that the start of fiscal consolidation during the current year was necessary, yet difficult given the election calendar and the provisions of the new pension law, and that the measures incorporated in the budget programme approved for 2020 went into the right direction, but seemed to be insufficient for meeting the set deficit target. Moreover, it was shown that resorting to a gradual fiscal correction and refraining from tax hikes during 2020 would prevent a sudden economic slowdown and all the more so a recession, hence a potential worsening, against that background, of domestic and external disequilibria.

The deterioration trend of the economy’s external position was considered a matter of increasing concern, in view of the heightened risks to macro-stability, but also to the sustainability of economic growth. In the related assessments, Board members referred again to non-price competitiveness issues in some sectors, but also to price competitiveness losses recorded by some industries/companies, stemming from increases in wage costs amid the relative stability of the leu exchange rate. Furthermore, Board members reiterated the need for an orderly correction of the external imbalance, primarily through fiscal adjustment, complemented by significant structural reforms, underlining again the need for a balanced macroeconomic policy mix to avoid the overburdening of monetary policy, with undesired effects in the economy.

Some members were of the opinion that high uncertainties continued to stem from the external environment as well, given on one hand the relative halt seen recently in the weakening trend of the euro area and global economies, largely amid loose financial conditions, and on the other hand the heightened geopolitical tensions, as well as the potential resurgence of risks induced by the global trade row and by Brexit. Mention was also made of the uncertainties deriving from the content and multitude of the recently approved or announced fiscal and budgetary measures – with a potential direct or indirect impact on the future behaviour of inflation –, but also from their degree of correlation with the budget programme.

In that context, the importance of an adequate dosage and pace of adjustment of the monetary policy stance was reiterated, with a view to anchoring medium-term inflation expectations and bringing back and keeping the annual inflation rate in line with the inflation target, while safeguarding financial stability. At the same time, it was deemed that, given the macroeconomic conditions and the domestic and external risks, maintaining strict 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 maintaining strict control over money market liquidity; moreover, 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.