Banca Naţională a României

Global and European economies started to recover in May amid the gradual lifting of physical mobility restrictions, yet activity remained at much lower levels than prior to the coronavirus spread. At the same time, their pace of recovery remains uncertain in the near run, depending on the pandemic evolution and the associated measures, yet also supported by the fiscal measures that the authorities have implemented, as well by the accommodative monetary policies of central banks in the advanced and emerging economies, including the ECB and central banks in the region. On the domestic front, the incoming data and information since the last NBR Board meeting at end-May have shown a severe impact of the coronavirus pandemic, especially in April, but also the economic and financial effects of the gradual relaxation of the restrictive measures starting in May.

The annual CPI inflation rate continued to drop in May to 2.26 percent (from 2.68 percent in April), while in June it went up to 2.58 percent, i.e. slightly above the mid-point of the flat target, amid base effects and the resumed pick-up in the oil price. Compared to the 3.05 percent level reported at the end of the previous quarter, the annual inflation rate followed a downward path – slightly steeper than projected –, owing to the markedly larger decline in fuel prices in annual terms.

The annual adjusted CORE2 inflation rate (which excludes from the CPI inflation administered prices, volatile prices, and tobacco product and alcoholic beverage prices) saw only a minor, lower-than-projected, fall in Q2 to 3.7 percent in June from 3.86 percent in March, the significant disinflationary base effect notwithstanding. Its evolution is further marked by the demand-pull and wage cost-push inflationary pressures built up prior to the pandemic crisis outbreak, likely to foster the persistence of this component. In recent months, to these have added the influences of changes in the consumption structure brought about by the pandemic and social distancing, as well as the impact of cost increases associated with bottlenecks in production and supply chains and with the measures to prevent the coronavirus spread.

Average annual CPI inflation rate and average annual inflation rate calculated based on the Harmonised Index of Consumer Prices dropped to 3.3 percent and 3.2 percent, respectively, in June from 3.6 percent in April. Economic growth decelerated considerably in 2020 Q1 to 2.4 percent from 4.3 percent in the preceding quarter, but its quarterly dynamics remained in positive territory at 0.3 percent. At the same time, the trade deficit posted a markedly faster widening in this period amid the pronounced decline in exports of goods and services, while the current account deficit coverage by foreign direct investment and capital transfers deteriorated further. The latest developments in high-frequency indicators suggest a severe contraction of the economy in Q2, in line with the forecasts, in view of the strong decline in April – a month fully impacted by containment measures –, which has started however to be reversed in May, when the state of emergency was replaced with the state of alert. Thus, in May, retail trade and motor vehicles and motorcycles sales saw a notable narrowing in their particularly large decline in annual terms reported in April, whereas the volume of construction works rose further at a fast pace in the first two months of Q2, albeit markedly slower than in the previous quarter. The revival of services to households was, nevertheless, much more subdued in May, after the massive fall in April, while the annual dynamics of the industrial output and of new orders in manufacturing remained deep in negative territory, in spite of visible increases from April, while net direct investment flows saw a new plunge in annual terms throughout the interval. Moreover, the advance in trade deficit posted only a mild slowdown.

Financial market conditions continued to improve amid the new monetary policy decisions taken at end-May. Key interbank money market rates consolidated their decline and subsequently their lower levels, and yields on government securities extended their downward course, given the significant volume of liquidity provided by the NBR via bilateral repo operations and purchases of leu-denominated government securities on the secondary market, in the context of a sizeable liquidity deficit on the money market; the stock of repo operations posted a daily average of lei 4.8 billion June through July 2020 and the volume of government securities purchased by the central bank reached a similar figure, i.e. nearly lei 4.8 billion, at end-July. In turn, the average lending rate on new business followed a clear-cut downtrend in 2020 Q2, while the average remuneration of new time deposits fell only slightly, with the related spread narrowing considerably.

At the same time, the EUR/RON exchange rate was further quasi-stable, and even tended to decrease somewhat in July, in step with the movements of other currencies in the region, amid the upbeat sentiment instilled by the EU’s major economic recovery plan.

The expansion in credit to the private sector saw its deceleration rate slow markedly in June to 4.1 percent, against 4.5 percent in May, due solely to the leu-denominated component, also upheld by the IMM Invest Romania Programme. The share of domestic currency loans in total private sector credit widened to 67.8 percent, hitting a record-high for the post-May 1996 period.

In today’s meeting, the NBR Board examined and approved the August 2020 Inflation Report, which incorporates the latest available data and information.

The new scenario reconfirms the expected trajectory of the annual inflation rate highlighted in the previous forecast, with a slightly downward revision over the near-term horizon. Specifically, the annual inflation rate is anticipated to increase slightly in July as well, and thereafter to remain relatively stable in the upper half of the variation band of the target until the end of this year, before declining and hovering moderately around the mid-point of the target amid the lagged action of disinflationary effects from the aggregate demand deficit; this is expected to open up markedly in 2020 Q2, but then to narrow gradually and somewhat faster than in the previous forecast. The uncertainty surrounding the new macroeconomic projections continues to be extremely elevated in the current environment, triggering two-way risks to the inflation outlook over the projection horizon. Their major source remains, at least in the short run, the coronavirus pandemic – which has resurged of late – and the associated containment measures that weigh on the speed and path of economic recovery, the government’s support programmes and the NBR’s monetary policy measures notwithstanding.

Major uncertainties relate further to the fiscal and income policy stance, given the possibly sharper increase in budget expenditures this year, also as a result of higher social transfers, in the run-up to this year’s elections – with consequences for the economy’s external position as well. At the same time, the fiscal consolidation that will probably start subsequently may be partly countered in terms of economic impact by the funds allocated to Romania via the EU’s recently-agreed economic recovery package and multiannual budget.

Significant uncertainties and risks also stem from the external environment, given the somewhat more encouraging signals on the recent developments in Europe’s economies, but also amid the resurgent pandemic over the last month, which may have an impact on the pace of recovery of economic activity and global trade.

In today’s meeting, based on the currently available data and assessments, but also in light of the extremely high uncertainty, the NBR Board decided to cut the monetary policy rate to 1.50 percent per annum from 1.75 percent per annum starting 6 August 2020. Moreover, it decided to lower the deposit facility rate to 1.00 percent per annum from 1.25 percent per annum and the lending (Lombard) facility rate to 2.00 percent per annum from 2.25 percent per annum. Furthermore, the NBR Board decided to maintain the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions. Given the liquidity shortfall on the money market, the Board decided to further conduct repo transactions and continue to purchase leu-denominated government securities on the secondary market.

The NBR Board considers that, given the transmission lags of the lower policy rate impulses, such a calibration of the monetary policy conduct is likely to provide an underpinning to the recovery of economic activity over the projection horizon with a view to bringing and strengthening over the medium term the annual inflation rate in line with the 2.5 percent ±1 percentage point inflation target, while safeguarding financial stability.

The new quarterly Inflation Report will be published on the NBR’s website on 6 August 2020 at 12:00 p.m. The account (minutes) of discussions underlying the adoption of the monetary policy decision during today’s meeting will be posted on the NBR’s website on 14 August 2020, at 3:00 p.m.