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; Leonardo Badea, Board member and Deputy Governor of the National Bank of Romania; Eugen Nicolăescu, Board member and Deputy Governor of the National Bank of Romania; Csaba Bálint, Board member; Gheorghe Gherghina, Board member; Cristian Popa, Board member; 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.
Looking at the recent developments in consumer prices, Board members showed that the annual inflation rate had exceeded the upper bound of the variation band of the target to a significantly larger extent in the first two months of 2021 Q3 and had mildly outpaced the forecast, going up from 3.94 percent in June to 4.95 percent in July and to 5.25 percent in August. It was observed that the new pick-up as well had been driven almost entirely by exogenous CPI components, with the major impact coming that time round from the considerable hike in natural gas and electricity prices in July, alongside the more subdued influences of the further rise in fuel prices, mainly on account of other fuels than petrol and diesel.
At the same time, it was remarked that the annual adjusted CORE2 inflation rate had followed a slightly sharper upward path, also compared to expectations, to reach 3.2 percent in August from 2.9 percent in June. The advance had been however largely triggered by the processed food segment, primarily owing to the climb in the prices of agri-food commodities, whereas the growth rates of non-food and services sub-components had seen relatively minor increases, reflecting mixed developments across both groups. Following the analysis, Board members agreed that the recent slightly upward trend in core inflation was mainly attributable to domestic and external supply-side shocks, particularly to the rising prices of some commodities and higher energy and transport costs, as well as to persistent bottlenecks in production and supply chains, the direct and indirect effects of which continued to be fuelled by the stronger demand for goods and services after the easing of mobility restrictions.
Mention was again made of the forced or precautionary household savings during the social distancing period, as well as of the still strong, albeit slowing dynamics of real disposable income over the last months, however reflecting a notable base effect too. Reference was also made to the fast-paced rise in industrial producer prices on the domestic market, as well as to the pass-through of higher energy prices into consumer prices, also with a focus on the recently stronger upward trend of short-term inflation expectations, as reported by several categories of economic agents, alongside a mild upward adjustment of longer-term inflation expectations.
As for the cyclical position of the economy, Board members noted that economic activity had continued to expand in 2021 Q2, at a relatively slower quarterly pace (1.8 percent compared to 2.5 percent in Q1), but somewhat brisker than anticipated, coming to moderately exceed its pre-pandemic level. It was remarked that the evolution made it likely for the aggregate demand surplus to increase during that period in line with the latest medium-term forecast. In addition, it had triggered a step-up in annual GDP dynamics to 13.0 percent in Q2, from -0.2 percent in Q1, amid the base effect associated with the sharp economic contraction in the same year-earlier period.
All major aggregate demand components had contributed to the abrupt pick-up in annual GDP dynamics, albeit to a considerably different extent. The main determinant had been household consumption – whose advance had been, however, lower than expected in annual terms –, its contribution being closely followed by the change in inventories. A positive contribution, albeit much more modest, had been made by gross fixed capital formation, in the context of renewed markedly faster growth in new construction works, mainly on account of residential construction works, which had outweighed the impact of the notable decline in the dynamics of net investment in equipment. Furthermore, the negative contribution of net exports to annual GDP dynamics had decreased in Q2, given that the sharply faster change in exports of goods and services during that period, also amid a base effect, had outpaced that in imports thereof.
The widening of the trade deficit had accelerated however in annual terms, while the current account deficit had continued to expand at a very fast pace, adding more than 85 percent in 2021 H1 overall versus the same year-earlier period. The developments were viewed as particularly worrisome by Board members, inter alia, amid a significant drop in the coverage of the current account deficit by autonomous capital flows in Q2, yet from a considerably higher level in the first month of the year.
Looking at the labour market, Board members observed a further recovery in recent months, albeit less strong at the beginning of H2, probably amid supply bottlenecks and uncertainties over hikes in costs of materials. Thus, the number of employees in the economy had continued to grow in June, remaining almost steady in July, at a level only slightly lower than the pre-pandemic one, while the ILO unemployment rate had stepped up its downward trend at end-Q2 to reach 5 percent from 5.3 percent in May, gradually returning, however, over the course of July and August, to 5.2 percent, i.e. by far higher than the low seen in January 2020.
The deceleration in the annual dynamics of wage earnings in June-July from the peak reached in the previous two months was, however, largely attributable to the base effects associated with last year’s developments, while the growth rate of private sector wages had come to exceed by far that of public sector wages, some Board members underlined. They also deemed relevant the information on the swifter pace of recruitment over the summer to record highs for the last years, as well as the mismatches between demand and supply in certain labour market segments, likely to generate pressures on wages.
Reference was also made to recent surveys indicating a further advance in employment in 2021 Q4, albeit somewhat more moderate, an outlook deemed by Board members to be, however, uncertain in the current context, given the accelerated worsening of the epidemiological situation domestically and the very low level of vaccination. The government’s new job retention measures, as well as the much lower stringency of the restrictions probably reinstated could nevertheless mitigate the adverse impact of the new pandemic wave, according to several Board members.
Over a somewhat longer horizon, however, uncertainties increased over the ability of some businesses to remain viable after the cessation of government support programmes and measures, especially in the context of a particularly large pick-up in energy and other commodity and intermediate goods prices, and of protracted supply chain issues, possibly leading to restructuring or winding-up of some firms. Labour market conditions could also be affected by the expansion of automation and digitalisation domestically and by employers’ growing resort to workers from abroad. Several Board members showed that, by contrast, opposite influences on wages were expected to arise from a possibly persistent skill mismatch, especially in highly-skilled labour segments, and to some extent from the likely hike, in the near future, in the minimum wage economy-wide.
Turning to financial market conditions, Board members observed that key interbank money market rates had posted upward adjustments in August and especially September – from their nearly four-year lows reached in June-July –, amid the central bank’s strict control over liquidity, but also the consolidation of expectations on a policy rate hike in the near future. In turn, yields on government securities had witnessed a steeper upward path in the latter part of Q3, particularly for the medium and long maturities, reflecting global financial market developments as well. Lending rates on the main types of new business to non-bank clients had continued to fall July through August 2021, with some exceptions, influenced, inter alia, by the protracted decline in the IRCC. However, its decrease had slowed down markedly in 2021 Q4, some Board members underlined, and the index would probably go up in 2022 Q1 for the first time ever.
Board members also pointed out the relatively sharp increase in the EUR/RON exchange rate in mid-August, after the decline recorded in the first part of Q3 under the influence of seasonal factors, as well as the moderate uptrend witnessed subsequently by the currency pair, inter alia amid the narrowing short-term interest rate differential – following the renewed policy rate hikes by two central banks in the region – and then owing to heightening tensions on the domestic political scene. Under the circumstances, it was repeatedly shown that the higher uncertainties about the budget consolidation stemming from the current political context, alongside the size of the external imbalance and the inflation dynamics, were conducive to a rise in the sovereign risk premium, with potential adverse consequences for the leu’s exchange rate, implicitly for inflation, confidence in the domestic currency and external vulnerability indicators, as well as for the financing costs of the economy.
Board members also remarked the swift growth rate of credit to the private sector, which had climbed more firmly in the two-digit range during the first two months of 2021 Q3, due to the unprecedented step-up of lending in local currency in July, including with the support of government programmes, but also to the moderate pick-up in the dynamics of foreign currency credit. Members highlighted the record volumes hit in July by new housing loans in domestic currency and by consumer credit, as well as the increase in the flow of leu-denominated loans to non-financial corporations close to historical highs. Hence, the stock of the leu-denominated component had seen its pace of increase accelerate further, averaging out at a five-year high of 17.4 percent July through August, from 15.2 percent in Q2, its share in total private sector credit widening to 71.3 percent in August.
As for future developments, Board members showed that, according to the new data and analyses, the annual inflation rate would probably rise over the short time horizon to much higher values than those anticipated in the August forecast, which had indicated a 5.6 percent peak in December 2021 and levels of around 3.4 percent starting 2022 Q3, marginally below the upper bound of the variation band of the target.
The considerable worsening of the near-term inflation outlook was further attributable to the strong adverse supply-side shocks, particularly external ones, whose impact was, however, compounded on the domestic front by the liberalisation of the electricity market for household consumers in 2021, Board members repeatedly underlined. Determining factors for the near-term outlook referred to the renewed large hikes anticipated for energy prices – especially of natural gas – and, to a smaller extent, for fuel prices, mainly on the back of the non-petrol-diesel component. To those added the further increase recorded in September by tobacco product prices, as well as the relatively higher dynamics expected for administered prices. They were likely to lead to a considerably larger and more protracted positive deviation of the annual inflation rate from the upper bound of the variation band of the target, Board members noted, while generating significant disinflationary base effects over the longer time horizon.
The inflationary impact of supply-side shocks could be even stronger and lengthier than in the current assessments, several members cautioned, indicating the steady and/or abrupt rise in the prices of some energy and non-energy commodities, as well as the persistence of bottlenecks in production and supply chains, associated with increased transportation costs, visibly affecting – directly or indirectly – core inflation also, inter alia via import prices. Mention was also made of the large share of food, energy and fuels in the CPI basket, as well as of the potential pass-through of higher costs of materials to consumer prices, amid the still robust, albeit moderating demand, alongside the foreseeable rise in prices of compulsory motor third-party liability insurance policies.
In that context, Board members voiced serious concerns over the risk that the inflation bout driven by supply-side shocks – implying the considerable and relatively persistent climb of the annual inflation rate above the variation band of the target – might deteriorate medium-term inflation expectations and thus trigger significant second-round effects, possibly via a wage-price spiral, given also the downtrend in the degree of labour market looseness. Under the circumstances, the need for anchoring medium-term expectations was repeatedly underscored, also from the perspective of central bank credibility. At the same time, it was agreed that any potential central bank attempt to ward off the direct transitory direct effects of adverse supply-side shocks would be not only ineffective, but even counterproductive, in view of the sizeable losses it would cause to economic activity and employment over a longer horizon.
As for demand-side inflationary pressures, Board members observed that the new assessments pointed to a slowdown in the dynamics of economic activity excluding agriculture in 2021 H2, also compared to earlier forecasts, considering, inter alia, the erosion of households’ and firms’ income by costlier energy, fuels and food; those developments rendered likely a quasi-standstill of excess aggregate demand in the latter part of the year, as compared to the slight increase forecasted previously. Thus, given their lagged pass-through, the inflationary pressures from the aggregate demand surplus would probably remain subdued and softer in the short run than anticipated in the August forecast and, at the same time, hardly discernible among the multitude of factors that would affect core inflation during that period, Board members concluded.
Looking at overall GDP growth, a slight pick-up was, however, to be expected for Q3, due to the very good performance of agriculture, implying – in the context of the base effect associated with the sizeable recovery in the same year-earlier period – a modest decline in its annual dynamics during the first three months of 2021 H2, Board members remarked. Moreover, it was noted that, according to recent developments in relevant indicators, the further swift growth in annual terms of the economy in Q3 was probably underpinned by domestic demand alone – primarily by private consumption and, to a smaller extent, by gross fixed capital formation. Conversely, net exports could make a larger negative contribution to annual GDP dynamics, as exports of goods and services had seen in July a much heftier contraction in their annual rate of change than imports, leading also to a strong acceleration of the annual growth of the trade deficit. Against that background, January through July overall, the current account deficit had continued to exceed by more than 70 percent the level recorded in the same year-ago period, some members pointed out, despite the further relatively more favourable developments in income balances.
In that context as well, the fiscal policy stance, presumed to become restrictive starting 2021, was considered a matter of concern, as the coordinates of the recent budget revision and the domestic political instability were likely to jeopardise budget consolidation, several members pointed out. Specifically, budget consolidation was seen as key for external imbalance correction and also necessary in terms of the commitments made under the excessive deficit procedure. It was deemed that additional uncertainties and risks surrounding public finance stemmed from the large volume of permanent expenditures and from the surge in the prices of energy and building materials, but also from potential approaches meant to cushion the impact of some costlier utilities, primarily for households, as well as from new government measures warranted by the abrupt worsening of the epidemiological situation.
Board members were of the opinion that a high degree of uncertainty was, however, also associated with the outlook for the absorption of EU funds allocated to Romania via the Recovery and Resilience Facility, as well as of those under the new Multiannual Financial Framework 2021-2027. They referred to the approval by the EC of the National Recovery and Resilience Plan, but also to the steps that still needed to be completed ahead of the commitment of funds, as well as to Romania’s institutional capacity and track record in that respect.
Furthermore, Board members repeatedly underlined that the new pandemic wave posed increased uncertainties and risks, highlighting the quick worsening of the health situation and the very low level of vaccination on the domestic front, but also the less severe restrictions probably reinstated, as well as the enhanced capacity of firms and households to adapt to social distancing requirements.
In the Board members’ opinion, the analysed context called for the further adjustment of the monetary policy stance via an increase in the monetary policy rate by 0.25 percentage points, after the discontinuation in May of the purchase of leu-denominated government securities on the secondary market and the subsequent tightening of central bank control over money market liquidity.
Such a calibration of the monetary policy conduct aimed to bring back and maintain over the medium term the annual inflation rate in line with the 2.5 percent ±1 percentage point flat target, inter alia via the anchoring of inflation expectations over the longer time horizon, in a manner conducive to achieving sustainable economic growth in the context of the fiscal consolidation process, while safeguarding financial stability. Moreover, it was deemed necessary to closely monitor domestic and international developments so as to enable the NBR to tailor its available instruments in order to achieve the overriding objective regarding medium-term price stability.
Under the circumstances, the NBR Board unanimously decided to increase the monetary policy rate to 1.50 percent, from 1.25 percent, while maintaining firm control over money market liquidity; moreover, it decided to raise the deposit facility rate to 1.00 percent, from 0.75 percent, and the lending (Lombard) facility rate to 2.00 percent, from 1.75 percent. Furthermore, the NBR Board unanimously decided to maintain the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions.