The National Bank of Romania Board members present at the meeting: Mugur Isărescu, 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; Liviu Voinea, Board member and Deputy Governor of the National Bank of Romania; Marin Dinu, Board member; Daniel Dăianu, 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 medium-term forecast of macroeconomic developments submitted by the specialised departments, as well as on other available domestic and external information.

In their addresses, Board members first referred to recent inflation developments. It was noted that the annual inflation rate had confirmed the upward expectations in December 2016. Its level of -0.54 percent had been slightly lower than projected, owing to the larger-than-expected drop in November, when it had fallen to -0.67 percent. It was observed that, during 2016 Q4 as a whole, the annual inflation rate had risen marginally and that, in the absence of the impact of lowering the standard VAT rate from 24 percent to 20 percent, it would have increased to 0.85 percent in December. Behind the step-up in the annual inflation rate had stood primarily the faster dynamics of fuel prices, which had reverted to positive readings in December, prompted by the advance in oil prices on international markets. Opposite influences had come from the slower rate of change of tobacco product prices, largely attributable to a base effect, and from the very slight deceleration of core inflation.

Board members pointed out that the slight decline in the annual rate of adjusted CORE2 inflation towards end-2016 had mainly been caused by the unexpected cut in prices of compulsory motor third-party liability insurance policies in November and, to a small extent, by the relative slowdown in the annual depreciation of the domestic currency in December. It was considered that a certain role may have also played the early incorporation by some retailers of the standard VAT rate cut scheduled for January 2017. It was deemed that, under the circumstances, recent developments in core inflation further hinted at the build-up of inflationary pressures from fundamentals, albeit at a slower pace than anticipated, amid the advance in excess aggregate demand coming to a halt in 2016 Q3, as well as the still high dynamics of unit wage costs in industry.

Looking at economic activity, reference was made to the stronger-than-expected deceleration of GDP growth in 2016 Q3, given the slower increase in domestic demand, on account of the slowdown in household consumption and gross fixed capital formation. Conversely, net exports had seen their negative contribution to real GDP growth shrink, in the context of a much sharper decline in the growth rate of imports compared to that of exports of goods and services. Board members remarked that the latest economic developments indicated a slight pick-up in quarterly GDP dynamics in 2016 Q4, implying the resumed growth of excess aggregate demand and of the ensuing inflationary pressures. Moreover, the latest developments pinpointed consumer demand as the quasi-sole driver of economic growth in Q4, as well as a possibly negative contribution of investment to GDP dynamics. Relevance was attached – on one hand – to the more robust growth of the turnover volume of retail trade and automotive sales October through November, along with the significant improvement in the consumer confidence indicator, and – on the other hand – to the steep contraction in civil engineering works, entailing a drop in the overall construction volume.

It was highlighted thereafter that the number of employees economy-wide had continued to increase during the first months of 2016 Q4, while the ILO unemployment rate had fallen to 5.5 percent in December, comparable to the lowest pre-crisis level. Board members considered that a labour shortage was manifest and emphasised the importance of addressing structural rigidities in this market. It was observed that the annual growth rate of the average net wage earnings economy-wide had witnessed only a very slight slowdown October through November, similarly to the dynamics of unit wage costs in industry, and had remained in the two-digit range.

When discussing future developments, Board members remarked that the new medium-term forecast reconfirmed the outlook for the inflation rate to rise progressively over the projection horizon, despite a slight change in the trajectory of its annual dynamics. Specifically, it was noted that the projected return of the annual inflation rate to positive territory in 2017 Q1 – amid the fading out of the impact of the first cut in the standard VAT rate – was at lower-than-previously-anticipated levels, owing primarily to the two new disinflationary supply-side shocks that had occurred from November 2016 to February 2017, i.e. the price reduction in compulsory motor third-party liability insurance policies and the scrapping of non-tax fees and charges. Moreover, the subsequent upward path of the projected annual inflation rate was seen re-entering the variation band of the flat target not earlier than 2017 Q4, namely with a relative lag vis-à-vis the previous forecast. Some Board members pointed out that, given the standard VAT rate cut to 19 percent and the removal of the special excise duty on fuels as from 1 January 2017, as well as following the new disinflationary supply-side shock in February, the monthly inflation rate would probably be negative in the first two months. At the same time, however, it was stressed that the forecasted path of the annual inflation rate had been revised upwards over the longer horizon. In particular, it was seen climbing higher in the upper half of the variation band of the target in 2018 Q2 and nearing the upper bound of this band in December 2018.

The assessment made by Board members revealed that the prospects for a step-up in inflation were underpinned, to a certain extent, by supply-side factors, particularly by the base effects associated with the cuts/removal of indirect taxes/fees and charges and by the increase in fuel prices, amid the expected consolidation of the uptrend in international oil prices. To these added the anticipated impact stemming from the higher prices for vegetables, fruit and eggs, as well as from the return of administered price dynamics to positive readings in the second half of the projection horizon, after the likely decline recorded in 2017, prompted by the recent reduction in the electricity price and by the scrapping of non-tax fees and charges. Against this background, Board members underlined the heightened uncertainties surrounding the projected paths of exogenous CPI components, generated by both domestic developments/events and possible developments in international markets. It was concluded that the balance of risks to short-term evolution of administered prices was tilted to the downside, whereas the balance of risks associated with global oil prices seemed to be in relative equilibrium. Furthermore, it was considered that, if such risks were to materialise, the likelihood of a lasting impact on inflation expectations over the medium term – and hence on CPI performance over a longer time horizon – would be low.

At the same time, Board members highlighted the decisive contribution to the outlook for a higher annual inflation rate from fundamentals, captured primarily by core inflation. The latter was expected to witness a strong acceleration, albeit unevenly distributed over the projection horizon, with the forecasted annual adjusted CORE2 inflation rate rising more slowly in 2017 than in the previous projection, yet at a faster pace in the second part of 2018. It was stressed that the major determinant of this core inflation pattern was the dynamics of excess aggregate demand and of its inflationary pressures, anticipated to be slacker than in the prior projection over the very short term and markedly faster thereafter, amid the relative step-up in the forecasted rate of quarterly GDP growth over the projection horizon, after the significant slowdown in 2016 H2. It was shown that stronger and/or rising inflationary pressures were also expected from unit wage costs, prices of imports – including against the backdrop of the likely increase in their volume –, as well as from inflation expectations, which were seen following a sharper uptrend.

Board members remarked that the annual GDP growth was expected to decelerate in 2017 and 2018 as compared to the dynamics probably recorded in 2016, although to a lower extent than anticipated in the previous projection. It was noted that the relatively swifter economic growth was backed by the recent cuts/removal of taxes/non-tax fees and charges, as well as by the new hikes in wages, pensions and other household income, to which added the accommodative real monetary conditions. Mention was also made of the stronger expansionary effects anticipated to emerge from the consolidation of economic growth in EU Member States and from the recovery of the global economy. Some Board members expressed their concern over the prospects that the contribution of private consumption to economic growth would consolidate, to the detriment of investment, whose contribution was anticipated to remain modest. It was considered that the advance in investment dynamics was conditional on the pace of EU funds absorption and on that of public investment, but also on the improvement in economic agents’ confidence and on corporate profits. The latter would probably be affected in the future by higher commodity- and wage-related costs, reflecting inter alia the further labour market tightening as a result of labour shortage. In turn, the contribution of net exports was anticipated to stay negative, although smaller than that probably recorded in 2016. Some Board members observed that the current account deficit-to-GDP ratio looked set to increase over the projection horizon, and hence the importance of keeping the deficit at sustainable levels was underscored; the re-emergence of twin deficits was pointed out.

In the Board members’ opinion, the uncertainties associated with the medium-term forecast continued to generate two-way risks to future inflation developments. The most significant were deemed to originate in the fiscal and income policy stance, given the possible deviation of the budget execution from the ambitious coordinates of the 2017 budget, including as regards the composition of public spending. Against this backdrop, mention was made of risks stemming from the possible additional consumption stimuli to the detriment of planned public investment, likely to affect the potential growth and the competitiveness of the Romanian economy and hence the medium-term performance of inflation and current account deficit. Reference was also made to the uncertainty surrounding the pace of EU funds absorption under the new Multiannual Financial Framework and the developments in the general domestic environment, with potential implications for the dynamics of economic growth and inflation in the future.

In the Board members’ assessment, the external environment also continued to pose mixed risks to domestic developments. Mention was made of the possibility of more robust economic growth in the euro area and globally, driven by the ongoing strongly accommodative ECB monetary policy stance, by the anticipated fiscal stimulus to the US economy, and by the potentially stronger recovery of major emerging economies, amid the rise in international commodity prices. At the same time, however, members noted downside risks to euro area economic growth arising from the uncertainties associated with the elections scheduled for this year and with the Brexit talks, as well as from the persistence of issues facing the European banking system. To these added the risks surrounding the recovery of emerging economies and of the global economy, stemming from the nature of some economic policies that could be implemented by the new US Administration and from geopolitical tensions. Moreover, Board members discussed potential influences exerted by the divergence of monetary policy stances of the world’s major central banks on the local financial market, also in the context of the regional economic and financial environment both in the current period and in the period ahead.

In light of the analyses, Board members judged it appropriate to leave the monetary policy stance unchanged, with a view to ensuring price stability over the medium term in a manner conducive to achieving sustainable economic growth. Specifically, the NBR Board unanimously decided to keep the monetary policy rate at 1.75 percent; in addition, the Board unanimously decided to maintain at ±1.50 percentage points the symmetrical corridor of interest rates on the NBR’s standing facilities around the policy rate, to further pursue adequate liquidity management in the banking system, as well as to leave unchanged the minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions.