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; Eugen Nicolăescu, 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 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 current and future macroeconomic, financial and monetary developments submitted by the specialised departments, as well as on other available domestic and external information.
In their addresses, Board members first examined the recent inflation developments. They observed that the annual inflation rate had continued to rise in the first two months of Q3 as a whole, posting a significant increase in July (to 1.42 percent from 0.85 percent), before a more modest decline in August to 1.15 percent. In the absence of all changes in indirect taxes, excise duties and non-tax fees and charges, the annual inflation rate would have gone up to 2.1 percent in August from 1.9 percent in June. The rise had primarily been driven by the electricity price hike, as well as by fuel price developments and faster core inflation. It was noted that their impact had been dampened by the base effect of tobacco product price dynamics and particularly by the unexpectedly sharp drop in prices of fruit and vegetables, which had caused the annual inflation rate to stand, in August, slightly lower than forecasted.
It was shown that the annual adjusted CORE2 inflation rate had, however, increased steadily, exceeding marginally the forecasted level – up to 1.60 percent in August from 1.42 percent in June. That time, the rise had owed mostly to services prices, given their relatively stronger sensitivity to EUR/RON exchange rate movements, with processed food prices having a smaller influence. When adjusted for the impact of the standard VAT rate cut, the annual adjusted CORE2 inflation rate had been 1.79 percent. Board members deemed that core inflation behaviour hinted at the build-up of inflationary pressures from fundamentals on the demand and cost sides, amid the more pronounced cyclical position of the economy and the hike in unit wage costs. According to some Board members, that behaviour also suggested a mitigation in the disinflationary influences generated by the indirect effects of past decreases in world oil prices and by heightened competition in retail trade and other sectors holding relevant shares in the CPI basket, as well as a potentially stronger role of import prices. It was noted that domestic pressures were further more clearly visible at the level of producer prices of consumer goods.
As for the cyclical position of the economy, Board members remarked that the positive output gap had probably seen a relatively larger expansion in Q2 as well, given that, contrary to expectations, economic growth had kept accelerating during that period, reaching 5.9 percent, from 5.7 percent in the previous quarter. In Q2, the swifter growth pace had been due to gross fixed capital formation and the change in inventories, whereas the prevalent contribution of private consumption to the annual GDP dynamics had remained unchanged. However, the contribution of net exports had again become significantly negative, amid the more pronounced deceleration in the growth rate of exports of goods and services than in that of imports thereof. It was noted that the sharp widening of the trade deficit and the worsening of the primary income balance had almost trebled the current account deficit in Q2 versus Q1, whereas the negative balance on trade in goods and services had hit a 19-month high in July. It was pointed out that the budget execution and the above-potential economic growth, as well as a certain rebound in private investment, were having an impact on the current account imbalance. Board members considered that developments were worrisome, inter alia in terms of the leu exchange rate developments, given also the lower coverage of the current account deficit by foreign direct investment and capital transfers.
It was noticed that, on the supply side, the swifter economic growth had benefited from quasi-general support; however, the advance in industry had been the main driver of the stronger increase in economic activity, ahead of the contribution of services, which had continued to hold a prevailing share in GDP, and that of agriculture. Conversely, construction had had a negative contribution for the first time in the past ten quarters, also as a result of weakening public investment amid the slow absorption of EU funds.
Looking at labour market developments, Board members observed that the number of employees economy-wide had reached successive record highs in June and July, despite its slower growth pace, while the unemployment rate had hit the second historical low in June and then had risen slightly in July. In addition, the number of job vacancies had increased markedly in Q2. It was concluded that, against that background, labour market tightening had grown significantly stronger of late and that it might persist, given that specialised surveys and analyses showed moderate employment intentions in the near run, but also major difficulties encountered by employers in recruiting skilled labour, as well as an increased staff turnover rate. In that context, it was shown that the annual growth rate of average gross nominal wage earnings economy-wide had picked up further in the period from June to July and consolidated at particularly high two-digit levels from a historical perspective and above those recorded in 2016. Moreover, the annual pace of increase of unit wage costs in industry had stepped up somewhat in July as compared with the Q2 average, amid the slightly slower dynamics of labour productivity.
Board members deemed that real monetary conditions had remained highly accommodative in July and August, amid the increase in the current and expected annual inflation rate, along with the fall in the average lending rate on new business and the standstill of the average interest rate on new time deposits in the vicinity of its historical low. Mention was also made of the strong pick-up in the dynamics of credit to the private sector over the past two months, up to a five-year high of 6.5 percent in August, driven primarily by the domestic currency component, whose share had widened to 61.0 percent. The stronger momentum was mainly visible across non-financial corporations, but also in the case of households, including consumer loans, business development loans and other loans, whose annual growth had peaked at an eight-year high. Reference was also made to the keener preference for liquidity, as broad money dynamics had accelerated during the past two months, mainly on account of the M1 monetary aggregate.
Board members then analysed, also from the perspective of monetary transmission, the pronounced uptrend in interbank money market rates towards end-Q3, noting that it had partly stemmed from the upward revision of inflation expectations and the stronger expectations on the adjustment of the monetary policy stance, inter alia in light of international financial market developments. Significant impetus had been given by the reduction in the structural liquidity surplus on the money market, under the simultaneous influence of the key autonomous liquidity factors, with a major role played by the operations in the Treasury account and by non-residents’ transactions on the local financial market, the latter reflecting a likely shift in the related risk perception. It was deemed that the daily reserve shortfalls occurring in that context would be relatively more lasting than the occasional ones emerging at the onset of a new reserve maintenance period, but that they were nevertheless temporary in nature, given the highly likely significant easing of the budget execution in the latter part of Q4. Under the circumstances, the supply of liquidity by the central bank via repo operations with full allotment was considered both appropriate and necessary. A potential lowering of the minimum reserve requirement ratio on leu-denominated liabilities of credit institutions starting with the 24 October - 23 November 2017 maintenance period was also brought into discussion.
Turning to future developments in the main macroeconomic indicators, Board members remarked that the short-term forecast reconfirmed the outlook for a further increase in the annual inflation rate over the months ahead, yet at a slightly quicker pace than that in the medium-term forecast published in the August 2017 Inflation Report. It was observed that the upward path would likely be driven to a larger extent by administered prices and fuel prices, whereas lower-than-previously anticipated contributions were expected from prices of vegetables, fruit and eggs and especially from core inflation, due inter alia to better agricultural output globally; it was pointed out that, in the case of administered prices, particularly of electricity and natural gas, as well as in the case of volatile food prices, the rises might however exceed expectations. Reference was also made to the coordinates and determinants of the NBR’s most recent medium-term forecast; according to it, the annual inflation rate was projected to pick up to 1.9 percent in December 2017, to 3.2 percent in December 2018 and to 3.5 percent in June 2019, amid the fading-out of one-off effects from cutting/scrapping indirect taxes, excise duties and non-tax fees and charges and against the backdrop of increasing inflationary pressures from aggregate demand and unit wage costs.
From that perspective, Board members showed that the new assessments indicated for 2017 H2 a markedly faster-than-previously forecasted economic advance in annual terms, with expectations pointing to a further step-up in GDP growth in Q3, followed by a slowdown in the closing quarter of the year. Those developments corresponded to a marginal upward revision of the quarterly GDP dynamics forecasted for Q3, along with a reconfirmation of the dynamics anticipated for Q4, both rates slowing down however compared with the preceding quarters respectively. It was noted that, given the significant unanticipated acceleration in the economic activity pace in 2017 Q2, the revision rendered highly likely a relatively wider positive output gap in the second half of the year as well. According to high-frequency indicators, private consumption could be the main driver of robust economic growth in Q3, followed by a modest contribution from gross fixed capital formation, while that from net exports would probably turn more negative.
Against this background, the majority of Board members deemed the balance of risks to the medium-term inflation forecast as tilted to the upside. The future fiscal and income policy stance was also considered a source of such risks, given both the one-off nature of an action entailing higher budget revenues this year and the expansionary effects of the new unified wage law, potentially alleviated however by the accompanying fiscal measures. Reference was made to the reversal in 2016 of the previous years’ fiscal consolidation. Moreover, discussants underlined the potential further reduction in public investment spending in favour of expenditures meant to foster consumer demand, conducive in time to a larger widening of the positive output gap, as well as of the current account deficit. Implications on future inflation, but also on competitiveness, might stem from a potentially higher increase in companies’ wage costs – amid the demonstration effect and labour market tightening, also due to the shortfall of skilled labour – and their no longer having room for a further narrowing of profit margins.
Board members also underscored the opposite risks that might arise over the short term from a relative slowdown in the advance of households’ real disposable income, owing to the increase in the excise duty on motor fuels and in the prices of some utilities. Reference was also made to the possibility of further corrective fiscal measures in the context of defining the outline of the 2018 budget, as well as to the prospects for implementing the recently adopted ones, likely to negatively affect inter alia household and investor confidence. Furthermore, it was pointed out that the markedly lower-than-expected rate of absorption of EU structural and investment funds under the 2014-2020 financial framework would likely continue, at least in the near future.
Looking at the external environment, Board members were of the opinion that it continued to generate two-way risks to the inflation outlook, given – on one hand – the potentially faster-than-expected growth of the euro area and global economies over the short time horizon and – on the other hand – the risks to the longer-term outlook for these economies induced by the US economic policies, the geopolitical tensions and the Brexit talks. Discussions also touched upon the implications of the recent downward revision of the medium-term inflation forecast in the euro area, also from the perspective of a potentially stronger influence of import prices on domestic inflation dynamics. Reference was also made to the ongoing reconfiguration of central banks’ policies, entailing a change in the path of interest rates on international financial markets. In this context, several Board members underlined the need for a balanced macroeconomic policy mix with a view to safeguarding macroeconomic stability. Some members remarked that an unbalanced policy mix overburdens monetary policy from the perspective of controlling inflation, decreases its efficiency and possibly entails less favourable effects in the real economy.
In the Board members’ opinion, the analysed context warranted the initiation of an adjustment in the monetary policy stance, with a view to ensuring the sustainable achievement of the medium-term inflation target, in a manner further supportive of economic growth. Specifically, the NBR Board unanimously decided to keep the monetary policy rate at 1.75 percent per annum, to further pursue adequate liquidity management in the banking system, and to leave unchanged the minimum reserve requirement ratio on foreign currency-denominated liabilities of credit institutions. Moreover, the Board decided with a majority of votes – 8 votes for, 1 vote against – to narrow the symmetrical corridor of interest rates on the NBR’s standing facilities around the policy rate to ±1.25 percentage points from ±1.50 percentage points, as well as to maintain the existing level of the minimum reserve requirement ratio on leu-denominated liabilities of credit institutions.