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 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 examined the recent inflation developments. They observed that the annual inflation rate had leapt to 1.77 percent in September from 1.15 percent in August, returning more deeply than anticipated into the variation band of the flat target. It was noted that the annual inflation rate had posted a faster-than-forecasted rise during Q3 too, and that, in the absence of all changes in indirect taxes, excise duties and non-tax fees and charges, it would have stood at 2.6 percent in September, marginally above the midpoint of the flat target. The upward movement in that period had been primarily driven by the increase in electricity price, to which had added the pick-up in fuel prices – amid the hike in the excise duty on motor fuels and in the international oil prices –, as well as the acceleration in core inflation; their impact had been only marginally offset by that of the decrease in the annual change of VFE prices and by the base effect associated with developments in tobacco product prices.
Board members remarked that the annual adjusted CORE2 inflation rate had more visibly outpaced the forecast, coming in at 1.83 percent in September from 1.42 percent in June, and that, in the absence of the standard VAT rate cut, it would have stood at 2.0 percent at end-Q3. The advance had mainly stemmed from services prices, which are more sensitive to leu exchange rate movements, and, to some extent, from processed food prices which are responsive to changes in commodity prices. However, on the whole, the rise had reflected the build-up of inflationary pressures from fundamentals, against the background of a further larger-than-expected increase in excess aggregate demand in Q2 and probably in Q3 too, as well as amid faster dynamics of unit wage costs. It was deemed that the recent core inflation behaviour hinted, however, at a drop in its sensitivity to the output gap and wage costs, in conjunction with a higher relevance of import prices, corroborated by the persistence of lower inflation in the euro area. Nevertheless, at the same time, Board members noted the markedly higher and increasing change in the industrial producer prices of consumer goods, assumed to largely pass through to the dynamics of consumer prices, with a certain time lag.
As for the cyclical position of the economy, Board members remarked that, according to the revised statistical data, economic growth in Q2 had posted a more pronounced acceleration in annual terms than that initially announced, reaching 6.1 percent from 5.7 percent in the previous quarter, and only a marginal slowdown in quarter-on-quarter terms, indicating a larger widening of the positive output gap in that period. The pick-up in growth had been mostly driven by the change in inventories and to a small extent by private consumption, which consolidated, however, its prevalent contribution to the annual GDP dynamics, as well as by gross fixed capital for¬mation, while net exports had acted in the opposite direction, their contribution turning negative again.
Moreover, Board members considered that, in H2, the annual pace of economic growth would probably exceed that seen in H1, as well as that previously projected, being expected to accelerate in Q3, before slightly slowing in Q4, and thereby carrying the potential for a relatively larger rise in excess aggregate demand. Monthly indicators pointed to private consumption as the main driver of economic expansion in Q3 too, with a relatively modest contribution of gross fixed capital formation coming in second. Conversely, net exports were anticipated to make a larger negative contribution to GDP dynamics, given that the unfavourable differential between the annual change in imports of goods and services and that in exports had continued to grow July through August, causing further widening of the trade deficit and of the current account deficit, with implications on the leu exchange rate behaviour.
Looking at labour market developments, Board members underlined the record high posted in August for the fourth successive month by the number of employees economy-wide, as well as the steepening downward trend in its annual growth rate, showing a potential decrease in the room for employment to grow and increased obstacles to recruitment faced by firms. The new decline in the unemployment rate to 5.0 percent in September was also referred to. Those developments, corroborated by the relative increase in employment intentions in the last months of the current year, as well as by higher difficulties in recruiting skilled labour, as revealed by specialised surveys, were deemed to indicate further labour market tightening. In that light, special reference was made to the high and growing annual dynamics of the average gross wage July through August, as well as to the two-digit level further posted by the annual change in the unit wage costs in some consumer-goods producing sub-sectors, which was, however, on a slight decrease across the industry as a whole. The need was reiterated to solve the structural market problems. Specifically, reference was made to the high inactivity rate in Romania and to the very low share of inactive population declaring they would be willing to work, reflecting not only the perception on the high opportunity cost related to relinquishing social security benefits in favour of employment, but also the limited access to the transport network and the information sources, as well as the generally low skills or competences that do not meet present requirements.The mentioned characteristics of an important part of the labour force pointed to obstacles in raising potential GDP growth, the relatively low labour market participation notwithstanding.
Relative to monetary conditions, Board members noted the advance posted in September by the average lending rate on new business and by the average interest rate on new time deposits. Those conditions were viewed as less accommodative in October too, given the significant advance and consolidation of the relevant money market rates above the policy rate – the highest in both the region and the EU –, as well as the marginal appreciation of the leu against the euro. In view of the persistence of the net liquidity deficit in the banking system, the central bank had continued to provide liquidity via repo operations. It was noted that, in September, the annual increase in credit to the private sector had continued to accelerate both in nominal and real terms, primarily on account of the lei component, the share of which had climbed to 61.4 percent in total private sector credit. That time, the pick-up in momentum had stemmed almost entirely from loans to legal entities, especially to non-financial corporations, which had increased particularly their short-term financing.
During the discussions on the new medium-term forecast, Board members observed the markedly changed path of the projected annual inflation rate, which headed sharply upwards and was substantially higher in the near run, before going down and standing over the second part of the projection horizon below the forecasted levels in the August 2017 Inflation Report. Specifically, after having risen to a foreseen 2.7 percent at the end of 2017, against the previously projected 1.9 percent, the annual inflation rate was expected to leap and remain until 2018 Q3 above the upper bound of the variation band of the flat target, before reverting and staying in its upper half, at 3.2 percent in December 2018, the same level as previously forecasted, and 3.1 percent at the end of the projection horizon, i.e. below the 3.5 percent value in the preceding projection.
Board members remarked that behind the upward revision of the short-term inflation outlook had stood the action of supply-side factors alone and hence that pick-up in inflation was of a transitory nature. The major influences were shown to come from the hike in the fuel excise duty, coupled with an anticipated higher international oil price, and from probably larger increases in some administered prices and in tobacco product prices. They would overlap early next year with the base effects associated with the previous cuts in indirect taxes and fees, but starting 2018 Q4 they would fade out or decline significantly.
Board members noticed that the uncertainties surrounding the projections of exogenous CPI components were rising, especially for electricity and natural gas prices, as well as for indirect taxes, which might be subject to a reconfiguration once the pending 2018 budget has been prepared/passed. It was deemed that the risks from these factors were, however, relatively balanced and that their materialisation could cause the annual inflation rate to temporarily deviate from the forecasted trajectory and could exert opposite influences on the real disposable income of households, and implicitly on consumer demand, over a longer horizon. Nevertheless, some Board members signalled also the risk that the bout of inflation early next year, possibly boosted and prolonged by the direct and indirect effects of potentially stronger supply-side shocks and/or by movements in the leu exchange rate, might affect, amid excess aggregate demand, the medium-term inflation expectations, and implicitly the path of inflation over a longer horizon.
At the same time, Board members noted that, over the longer time horizon, the sole determinant of the forecasted annual inflation rate remaining above the midpoint of the target was core inflation – primarily capturing the action of fundamentals –, whose annual pace was expected to rise gradually until the beginning of 2019 and subsequently level off at about 3.7 percent, i.e. above the variation band of the target. It was shown that the downward revision of the projected core inflation path owed almost solely to the decline in the sensitivity of adjusted CORE2 inflation to the action of fundamentals, together with the upward reassessment of the role played by import prices, given that the increase in excess aggregate demand was expected to be larger in the first part of the projection horizon than previously anticipated, unit wage costs in turn were seen growing at a faster pace, and short-term inflation expectations were following a slightly steeper upward trend; at the same time, the projected import price dynamics were marginally lower and the anticipated import volume was higher. It was noted that, towards the end of the projection interval, the revision reflected, however, a relative abatement in inflationary pressures driven by the positive output gap, given that at mid-2019 it was expected to resume a slightly downward slope and thus decrease to marginally lower levels than those previously forecasted, also as a result of the upward adjustment of potential GDP growth rate.
During the discussions on the likely pattern of excess aggregate demand, Board members remarked that economic growth in 2017 was expected to accelerate markedly faster than previously anticipated, before slowing down more steeply in 2018 and losing momentum moderately in 2019, its forecasted dynamics remaining above the potential GDP growth rate in 2018, but thereafter dropping to a slightly lower value. It was shown that the outlook relied on the expansionary nature of fiscal and income policies probably persisting into 2018, albeit gradually abating from 2016. It also implied monetary conditions would see a progressive reduction in their degree of accommodation against 2017, as well as the EU funds absorption would improve and euro area/EU and global economies would expand at a relatively more robust pace over the short term.
According to Board members’ assessment, household consumption would likely contribute more to economic growth in 2017-2018, whereas the contribution made by gross fixed capital formation could remain modest, yet relatively higher than previously assessed. Some Board members reiterated their concern about such a growth pattern, advocating the need for a rebound in investment, conditioned, however, on EU funds absorption and public investment, corporate profitability, as well as the quality of infrastructure and the availability of skilled labour force; moreover, of particular importance was seen to be investor confidence, depending also on the evolution of fundamentals and legislative framework predictability.
Following the analysis, many Board members found that the current context called for further adjustment of the monetary policy stance through another response in addition to that of narrowing the corridor of interest rates on the NBR’s standing facilities around the policy rate to the standard ±1.00 percentage point width. Out of the options under discussion, it was deemed that in the given context most adequate would be a change in the central bank’s liquidity management in the banking system so as to strengthen the impact and the relevance of the policy rate and its signalling role, implicitly the transmission of impulses of its prospective change.
Additional arguments for this move were the risk of stronger-than-expected pro-cyclicality of fiscal and income policies in 2018 or that of a more pronounced suboptimal nature of budget expenditure composition should the fiscal deficit be, however, capped at 3 percent of GDP, yet on the back of further cuts in investment spending, with adverse implications for the economy’s growth potential over the medium term and the current account deficit. Reference was also made to the uncertainties surrounding the fiscal strategy in general and the new package of fiscal and wage measures, likely to cause investor sentiment to worsen towards the local economy and financial market and the attached risk premium to widen, implicitly affecting the movements in the leu exchange rate. Moreover, discussions touched upon the risks to the inflation outlook stemming from a potentially higher increase in corporate costs, along with tighter profit margins, due mostly to the new fiscal measures and labour market tightening.
At the same time, however, potential contractionary effects on the economy were signalled. They were seen coming from the new package of fiscal and wage measures and the potential additional corrective steps approved in the context of drafting the 2018 budget and weighing on economic activity chiefly by affecting costs and business confidence, as well as households’ real disposable income dynamics. Discussions also touched upon the risk of a protraction in the anaemic nature of EU funds absorption under the 2014-2020 financial framework. Turning to the external environment, the possibly weaker-than-anticipated performance of euro area inflation was mentioned, despite potentially faster-than-expected growth of European and global economies over the short time horizon. Special relevance was attached by some Board members to the monetary policy stances of the major central banks and to the behaviour of central banks in other countries in the region, where higher inflation rates prevailed, but relatively consolidated macroeconomic equilibria were also manifest. In this context, several Board members underlined the need for a balanced macroeconomic policy mix with a view to safeguarding macroeconomic stability. A balanced mix was also deemed necessary from the standpoint of avoiding the overburdening of monetary policy, with a view to preventing undesired effects across the economy, among which a possible slowdown or even a reversal of de-euroisation.
Against this background, the NBR 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 percentage points from ±1.25 percentage points and, unanimously, to ensure firm liquidity management in the banking system. Moreover, the Board decided with a majority of votes – 8 votes for, 1 vote against – to keep unchanged the monetary policy rate at 1.75 percent per annum and, unanimously, to maintain the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions.