Banca Naţională a României

Global and European economies saw a strong, albeit partial, rebound in Q3, thanks to fiscal and monetary policy support, but their near-term outlook deteriorated visibly, under the impact of the new pandemic wave and the tightening of the related containment measures.

On the domestic front, the incoming data and information since the NBR Board meeting held in August also show a larger-than-expected upturn in the economy over the summer, supported by government programmes and the NBR’s monetary policy measures. However, the recovery will probably come to a halt towards the end of the year or even see a slight reversal amid the resurgence of the pandemic and the mobility restrictions.

The annual CPI inflation rate decelerated to 2.45 percent in September (2.68 percent in August) and to 2.24 percent in October, running thus visibly below the projected level, mainly amid the much larger-than-expected decline in the prices of fruit and vegetables. The inflation rate therefore recorded a decrease versus the last month of Q2, when it stood at 2.58 percent, and an even larger fall when compared to the 4.04 percent level seen at end-2019.

The annual adjusted CORE2 inflation rate (which excludes from the CPI inflation administered prices, volatile prices, and tobacco product and alcoholic beverage prices) was, however, flat in Q3 and posted only a minor decrease in October, in line with forecasts, reaching 3.6 percent from 3.7 percent in June. Its evolution is further marked by the pre-pandemic underlying inflationary pressures, amid, inter alia, the recovery of consumer demand in Q3, to which add influences, albeit slightly milder, from supply-side disruptions/constraints and higher costs associated with the pandemic 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 2.9 percent and 2.7 percent respectively in October from 3.3 percent and 3.2 percent respectively in June.

In line with expectations, the economy witnessed a severe contraction in 2020 Q2, by 10.3 percent in annual terms and by 11.9 percent in quarterly terms, under the impact of the pandemic and the restrictive measures imposed during the state of emergency. The main driver of the decline was the plunge in household consumption, whereas gross fixed capital formation continued to rise mildly amid the hike in equipment purchases and the resilience of the construction activity. The annual dynamics of general government consumption remained in the two-digit range, albeit on a slight decrease versus the previous quarter.

Furthermore, the massive fall in exports of goods and services outpaced visibly the drop in imports thereof, causing the annual dynamics of the negative trade balance to step up again. The current account deficit continued, however, to narrow in annual terms due to the improved dynamics of the primary and secondary income balances, on account of the returns on equity holdings and inflows of EU funds.

The latest developments in high-frequency indicators show a more sizeable rebound in the economy in Q3 than previously anticipated, albeit uneven from a sectoral perspective. Thus, in July-August, in terms of annual dynamics, retail trade and motor vehicles and motorcycles sales returned to positive territory, coming again close to the volumes seen in February or even surpassing them, whereas the annual rate of change of services to households remained negative, but shrank to a third of that in the previous quarter. In addition, the annual increase in the volume of construction works stepped up slightly, while industrial output and the new orders in manufacturing recovered most of the decline in Q2; conversely, net direct investment flows saw a notable contraction in July-August as against the same year-earlier period. At the same time, the annual dynamics of trade deficit accelerated again in September, after the deceleration in the first two months of Q3.

Financial market conditions continued to improve under the impact of the three successive policy rate cuts and on the back of the liquidity provided by the central bank to credit institutions, conducive to the adequate financing of the real economy and the public sector, amid the relative stability of the EUR/RON exchange rate. Preserving confidence in the domestic currency, in the context of widening twin deficits, is a key element of monetary policy conduct this year, implying a gradual and sustainable reduction in interest rates on the money market and on leu-denominated loans. Key interbank money market rates stuck to a downtrend in the past months, albeit relatively slower and marked recently by some small fluctuations, while yields on government securities extended their downward course, with 10Y bonds hitting four-year lows. The average lending rate on new business to non-bank clients went further down in Q3, dropping at the end of the quarter to the lowest reading in almost three years.

The recent fluctuations of the EUR/RON exchange rate – brought about by the heightened global risk aversion amid the resurgence of the pandemic crisis, but also by domestic political decisions posing risks to public finance sustainability – have been far more moderate than those in the region.

The annual dynamics of credit to the private sector followed a slightly steeper upward path in September, after the shift in direction seen in August, reaching 4.0 percent, from 3.6 percent in July, amid the rebound in domestic currency lending, especially to non-financial corporations, also upheld by the IMM Invest Romania Programme. The share of leu-denominated loans in total private sector credit widened to 68.8 percent, hitting a record-high for the post-January 1996 period.

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

The new scenario partly reconfirms the expected trajectory of the annual inflation rate highlighted in the previous forecast, with a significant downward revision only over the short-term horizon. Specifically, the annual inflation rate is anticipated to decline further in the near future, to markedly lower values than previously envisaged, before climbing and remaining thereafter close to the mid-point of the target over the policy-relevant horizon, the same as in previous forecasts. At the same time, the outlook for adjusted CORE2 inflation is fully reconfirmed, as its annual rate is seen decelerating only slightly at end-2020, but much more visibly afterwards, declining in the latter part of next year and thereafter remaining slightly below the mid-point of the target, amid the disinflationary effects from the aggregate demand deficit.

The uncertainties surrounding the new macroeconomic projections continue 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 and the related containment measures – in the context of the new wave that gains increasing momentum –, as well as their impact on the domestic and European/global economies.

Heightened uncertainties and risks stem from the outlook of the fiscal and income policy stance, especially in the absence of the draft budget for 2021 and in the electoral context, given the potentially sharper increase in budget expenditures this year – with knock-on effects on future budget executions and hence on the sovereign risk premium –, as well as the budget consolidation necessary to be initiated in the near run; the impact of the consolidation could be partly counterbalanced by the intake of European 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 relatively more robust recovery of European economies in Q3, which could nevertheless be halted or even reversed slightly by the new pandemic wave and the associated containment measures.

In today’s meeting, based on the currently available data and assessments, but also in light of the extremely elevated uncertainty, the NBR Board decided to keep the monetary policy rate at 1.50 percent per annum; moreover, it decided to leave unchanged the deposit facility rate at 1.00 percent per annum and the lending (Lombard) facility rate at 2.00 percent per annum. Given the developments in foreign currency lending and the adequate level of forex reserves, the NBR Board decided to cut the minimum reserve requirement ratio on foreign currency-denominated liabilities of credit institutions to 5 percent from 6 percent starting with the 24 November – 23 December 2020 maintenance period. The measure also aims to continue the harmonisation of the minimum reserve requirements mechanism with the relevant standards and practices of the European Central Bank and the major central banks across the European Union. The minimum reserve requirement ratio on leu-denominated liabilities remains unchanged at 8 percent.

The NBR Board considers that 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 13 November 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 24 November 2020, at 3:00 p.m.