Summary

Developments in inflation and its determinants

The annual CPI inflation rate resumed its downward path in 2024 Q2, standing at 4.94 percent in June, i.e. 1.67 percentage points lower than in March. At the same time, due to a number of unanticipated favourable developments during Q2, especially in the utility (natural gas) price segment, in June headline inflation fell 1.1 percentage points below the forecast in the previous Inflation Report. Exogenous components accounted for about half of the progress seen in disinflation in Q2. Specifically, the auspicious conditions in wholesale markets for natural gas and electricity as well as a number of legislative changes allowed for a drop in these prices for household consumers. Moreover, although oil prices fluctuated in both directions during the months of Q2, the annual growth rate of fuel prices was lower at the end of the period than in March. In turn, the annual core inflation rate declined at a pace close to that seen in 2024 Q1, i.e. by 1.4 percentage points, with all three groups of the index contributing to disinflation to a relatively similar extent. The average annual inflation rate, a measure with inherently higher persistence, remained on a downward trend in Q2, with the indicator calculated based on the national methodology (CPI) falling to 7.2 percent and the indicator calculated in accordance with the harmonised structure (HICP) going down to 7.3 percent. Thus, during Q2 the correction amounted to 1.3 percentage points for the first indicator and to 1 percentage point for the second one. The differential against the EU average came in at 3.7 percentage points and hence remained close to that posted at the end of the previous quarter, reflecting further a slower disinflation in Romania.

The annual adjusted CORE2 inflation rate followed a steady downward path in 2024 H1, yet the pace of disinflation slowed down. In June, the annual adjusted CORE2 inflation rate declined to 5.7 percent, i.e. 0.2 percentage points below the forecast in the previous Inflation Report. In Q2, all three groups of the indicator had relatively balanced contributions to disinflation. However, the levels reported by the three sub-components remained strongly divergent. Food items made the strongest progress, their annual price dynamics falling to 2.1 percent. In contrast, although disinflation sped up in the non-food and services segments compared to the previous quarters, the annual growth rates of these prices are further elevated (8.6 percent and 8 percent respectively in June). The developments reflect the relatively favourable context, given the milder inflationary influences from input costs of materials and import prices – both having a relevant impact on non-food prices –, but also the softer demand for market services. Favourable contributions came also from economic agents’ short-term inflation expectations and financial analysts’ medium-term inflation expectations. Conversely, factors such as the pressure from wage costs and excess demand continue to hinder the disinflationary process of these components, putting core inflation on a slowly downward trajectory.

The annual dynamics of unit labour costs economy-wide continued to accelerate in 2024 Q1 to reach 21.6 percent (compared to 15.4 percent in the previous quarter), as the slowdown in economic activity was not accompanied by labour force or compensation adjustments. Thus, labour productivity shed 3.3 percent in annual terms, while the pace of increase of compensation per employee, albeit slower, remained fast (17.6 percent, -0.9 percentage points from 2023 Q4), further generating inflationary pressures. In industry, the annual growth rate of unit wage costs declined to 14.4 percent in April-May, from 18.1 percent in the previous two quarters, amid a low output volume, correlated with weak external demand. The moderation in the rate of increase of unit wage costs was almost across the board, with the following industries still recording larger fluctuations (above 20 percent): beverages, crude oil processing, manufacture of rubber and plastic products and manufacture of electronic products.

Monetary policy since the release of the previous Inflation Report

In its meeting of 13 May 2024, the NBR Board decided to keep the monetary policy rate at 7.00 percent per annum. The interest rates on standing facilities were also left unchanged at 6.00 percent per annum (the deposit facility rate) and at 8.00 percent per annum (the lending facility rate). In March the annual inflation rate returned to the level seen at end-2023 (6.61 percent), as the increases in the dynamics of electricity, fuel and tobacco product prices in 2024 Q1 overall were counterbalanced, in terms of impact, by the deceleration of core inflation and the decline in the dynamics of VFE prices. Specifically, the annual adjusted CORE2 inflation rate continued to fall in the first three months of 2024, albeit at a slower pace than in the previous two quarters. Behind the deceleration stood, during this period as well, disinflationary base effects, corrections of agri-food commodity prices and the measure to cap the mark-ups on basic food products, alongside the decreasing dynamics of import prices. The impact of these factors was mitigated by the effects of the fiscal measures implemented at the beginning of this year and by higher short-term inflation expectations. To these added the influences exerted by wage cost increases that occurred towards the end of last year, which were passed through, at least in part, into the prices of some services and non-food items, inter alia amid the rebound in private consumption.

Significant uncertainties and risks to the inflation outlook stemmed from the fiscal and income policy stance, given on one hand the budget execution in the first three months of the year, the public sector wage dynamics and the full impact of the new law on pensions, and on the other hand the additional fiscal and budgetary measures that could be implemented in the future to carry on budget consolidation, inter alia amid the excessive deficit procedure and the conditionalities attached to other agreements signed with the EC. Labour market conditions and wage growth in the economy were also a source of sizeable uncertainties and risks. Moreover, uncertainties and risks to the outlook for economic activity, implicitly the medium-term inflation path, continued to arise from the war in Ukraine and the Middle East conflict, as well as from the economic performance in Europe, especially in Germany. Furthermore, the absorption of EU funds, especially those under the Next Generation EU programme, is conditional on fulfilling strict milestones and targets. However, this is essential for carrying out the necessary structural reforms, energy transition included, as well as for counterbalancing, at least in part, the contractionary impact exerted by geopolitical conflicts. The ECB’s and the Fed’s prospective monetary policy stances, as well as the conduct of central banks in the region continued to be also relevant.

Subsequently, the annual inflation rate saw a faster decline in the first two months of 2024 Q2, falling to 5.12 percent in May, below the forecast, mainly as a result of the notable drop in energy prices, especially natural gas prices, following the legislative changes implemented as of April, as well as amid the further deceleration in the growth rate of food prices. At the same time, the annual adjusted CORE2 inflation rate continued to decrease gradually, in line with forecasts, down to 6.3 percent in May from 7.1 percent in March 2024. Behind the deceleration stood, during this period as well, disinflationary base effects and corrections of agri-food commodity prices. Additional influences stemmed from the decreasing dynamics of import prices and from short-term inflation expectations re-embarking on a slight downtrend. A moderate opposite impact had the new hikes in unit labour costs recorded in the first months of 2024, which were passed through, at least in part, into the prices of some goods and services, inter alia amid a robust consumer demand that increased strongly in April. In turn, economic activity expanded in 2024 Q1 to a lower extent than anticipated, after its contraction in 2023 Q4, which made it likely for excess aggregate demand to have further narrowed over this period, contrary to expectations. Moreover, annual GDP growth contracted markedly in 2024 Q1 to 0.1 percent from 3 percent in the previous three months. The decline was driven this time round mainly by gross fixed capital formation, whose annual dynamics plummeted from the very high two-digit level seen in 2023 Q4, whereas household consumption continued to witness a faster annual rise. In turn, net exports exerted a larger contractionary influence in 2024 Q1, against the backdrop of a slight pick-up in the differential between the positive dynamics of the import volume of goods and services and the change in the export volume, which remained in negative territory. However, the annual growth rate of the trade deficit remained unchanged, while that of the current account decreased considerably from the previous quarter, given, inter alia, the strongly faster increase in the secondary income surplus during this period, mainly on account of inflows of EU funds to the current account.

At the time of the NBR Board meeting of 5 July 2024, the latest assessments showed that the annual inflation rate would decline further over the following months, on a significantly lower path than that shown in the May 2024 medium-term forecast, primarily due to base effects and legislative changes in the energy field, as well as amid the deceleration in import price growth and the gradual downward adjustment of short-term inflation expectations. The previously identified risk and uncertainty factors remained relevant.

Considering the assessments and data available at that moment and the prospects for the annual inflation rate to decline further over the following months, on a significantly lower path than previously anticipated, but also in light of the still elevated uncertainty, the NBR Board decided to cut the monetary policy rate to 6.75 percent per annum from 7.00 percent per annum starting 8 July 2024. Moreover, it decided to lower the lending (Lombard) facility rate to 7.75 percent per annum from 8.00 percent per annum and the deposit facility rate to 5.75 percent per annum from 6.00 percent per annum. Furthermore, the NBR Board decided to keep the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions.

Inflation outlook

The global economy has continued its recovery after multiple overlapping supply-side shocks. Over the recent quarters, while global economic growth lost momentum, it showed resilience. At the same time, corrections in inflation rates were recorded, illustrating the remarkable progress made against the values reached at the height of the crisis. Inflation continued to be a matter of concern in the euro area, with supply-side shocks and stubbornly-high services price inflation still marking its path. In the region, economic activity showed signs of recovery, yet unevenly distributed across sectors and rather moderate, given the further tight financial conditions and numerous geopolitical uncertainties.

This raises the prospect of a relatively gradual economic recovery in the years ahead, influenced inter alia by persistent inflation and sluggish labour market adjustments. Moreover, global geo‑economic fragmentation trends, as well as the ongoing electoral “super-cycle” in both Europe and important geographical regions, with many successive election rounds scheduled for this year, also fuel the persistently high economic uncertainty.

In Central and East European economies, Romania included, inflation dynamics were influenced by both global factors and local policies. In particular, Romania faces a fiscal policy that calls for adjustments in order to attain a sustainable budget deficit. Given that the country continues to be subject to the excessive deficit procedure, taking adjustment measures is essential both to fend off more severe macroeconomic disequilibria and to secure fiscal sustainability over the medium and long term.

Thus, the global and regional economic prospects remain fragile, sometimes divergent, and riddled with significant risks. Particularly for the emerging economies, risks are associated with a potential volatility of capital flows, inter alia in connection with the calibration of monetary policies pursued by the world’s major central banks. For all these reasons, a cautious approach to managing economic policies is of the essence to ensure a sustainable economic recovery and to meet inflation targets in the medium term.

In the May 2024 Inflation Report, projections suggested that the weaker domestic economic activity in 2023 Q4 was only short-lived. This assessment was confirmed by the subsequently published NIS data, which indicated a return of GDP dynamics into positive territory in Q1, i.e. 0.7 percent. Nonetheless, the key components of domestic demand displayed softer-than-expected developments, with household consumption almost stalling against the previous quarter and gross fixed capital formation (GFCF) even decreasing in quarter-on-quarter comparison. Moreover, the faster recovery of economic activity in euro area trading partners earlier this year was accompanied by a mild decrease in the negative contribution of net exports to economic growth in Romania. In correlation with these developments, the positive output gap was stuck in 2024 Q1 to the downward path seen throughout the previous year, before reaching over the next two quarters values similar to those projected in the prior Report. Given that Romania continued to report excessive government deficits and, until the completion of the analysis, the authorities did not put forward a package of fiscal consolidation measures, excess aggregate demand is foreseen to persist throughout the eight-quarter projection.

In 2024 Q1, GFCF posted a quarter-on-quarter contraction, owing chiefly to theweaker-than-anticipated performance of construction. A reason behind the developments in the GFCF was probably that EU funds under the 2014-2020 financial framework were used up, as they reached an absorption rate of over 90 percent atend-2023. The evolution was also reflected in the dynamics of public investment, financed in the first part of the year mainly from own and borrowed sources and to a much lesser extent from EU funds. Furthermore, even though the Romanian authorities collected approximately EUR 9.4 billion from NRRP funds since the beginning of the programme, their actual use in the financing of investment programmes was rather modest at an estimated 20 percent of the total figure. Conversely, foreign direct investment remained a major funding source, with noticeably higher inflows than those of last year, yet debt instruments are favoured over equity in their composition, according to the latest data.

Despite posting a quasi-stagnation in 2024 Q1, private consumption is foreseen to return to robust rates of increase starting Q2 and, for the year as a whole, to become again the main driver of economic growth. In this vein, the groundwork for restoring households’ purchasing power was laid as early as last year and is set to strengthen in the future. Specifically, the ongoing disinflation, the effects induced by a still robust labour market, the sizeable contribution of public sector wage policies and strong rises in social transfers foreseen for 2024 H2 (e.g. the new pension law) are expected to underpin a steady expansion in domestic demand and private consumption. Even though the anticipated increase in real income will render more flexibility to households’ consumption expenditure, helping boost economic activity, looking ahead, it is particularly important to rebalance as fast as possible wage growth, which is already extremely strong, with productivity dynamics. Over the medium term, this process is essential not only to support the gradual return of inflation rate towards the target, but also to avoid further external competitiveness losses of Romania’s economy.

The current account deficit-to-GDP ratio narrowed by approximately 2.2 percentage points in 2023 from the year before, standing at 7 percent. Subsequently, statistical data showed this year a reversal of the downtrend of the indicator, due to less favourable contributions from most sub-components, with secondary income being the only notable exception. Looking at the dynamics, the recent developments in the current account deficit may partly be associated with seasonal effects affecting some components, yet structural causes prevailed, according to quantitative assessments. Specifically, thetourism-travel component, influenced chiefly by seasonal factors, saw a widening of its deficit this year as well, and, in turn, of its negative contribution to the current account deficit. Conversely, other components, such as net payments of portfolio investment income, accounting for approximately 15 percent of the current account deficit according to data for May, reflect a higher structural requirement for government deficit financing and public debt refinancing. Against this background, further larger adjustments to the current account deficit are strictly conditional on those to the budget deficit and, in particular, on bringing the latter back in line with the targets set in the excessive deficit procedure as quickly as possible. Of course, notable headway in the correction of the external deficit also hinges on a stronger recovery in the economic activity of EU trading partners, yet the progress made so far is still rather slow.

According to the updated baseline scenario, after standing at 4.94 percent in June 2024, the annual CPI inflation rate will follow a mostly downward path, with two dominant features. First, the pace of disinflation is projected to slow down in 2024, and particularly in 2025 and 2026. Second, the trajectory of the annual CPI inflation rate will be marked by some fluctuations, mainly as a result of base effects – e.g. the projection shows a low of 2.9 percent at the end of 2025 Q1 due to the hike in some indirect taxes (VAT and excise duties) in January 2024 dropping out of the annual inflation rate. Once base effects have faded out, the dynamics of the indicator stabilise in the upper part of the variation band of the target starting 2025 Q3, without exceeding, however, 3.5 percent. Specifically, the annual CPI inflation rate is projected to reach 4 percent at end‑2024, 3.4 percent at end‑2025 and 3.2 percent at the forecast horizon, i.e. June 2026. Partly due to the recent developments implying faster disinflation of most of the basket sub‑components, the new projected path of the annual CPI inflation rate is lower than in the previous Report, down 0.9 percentage points in December 2024 and by 0.2 percentage points in December 2025.

Over the entire projection interval, the adjusted CORE2 index will remain the major determinant of the decline in the annual headline inflation rate. At the same time, amid the recent legislative changes that enabled the cut in utility prices, especially natural gas prices, the contribution of exogenous components of the CPI basket to headline inflation will decrease slightly at the end of this year from end-2023 and will then stay at a relatively close level, i.e. 1.1-1.2 percentage points, also towards the end of the projection horizon. The annual adjusted CORE 2 inflation rate will follow a steadily downward course, driven by softer inflation expectations and abating pressures from import prices. However, core inflation will exceed headline inflation over most of the projection interval, given the still strong unit labour cost pressures fuelled by both recent and anticipated pay rises. Annual wage dynamics will stay relatively high, yet while in the private sector a deceleration is foreseeable during this year, in the public sector they will step up from last year, given the wage increases already enacted and partly already granted. For December 2024, the annual core inflation rate was revised downwards to 4.6 percent (-0.7 percentage points from the previous Report), amid visible progress especially in the non-food component. This was recently accompanied by a good performance also in the case of processed food and market services, which is anticipated to continue, albeit at a relatively slow pace for the latter. For this reason, in 2025 the differences in the indicator against the previous projection are diminishing markedly, while they benefit primarily from downward revisions in inflation expectations and, in part, in import prices. Conversely, the output gap will closely reflect the fiscal policy stance and the projected developments in the budget deficit. Hence, the annual core inflation rate is seen dropping to 3.5 percent in December 2025 and thereafter to 3.4 percent in March and June of 2026.

The NBR’s recent monetary policy stance aimed to bring the annual inflation rate back in line with the 2.5 percent ±1 percentage point flat target on a lasting basis, inter alia via the anchoring of inflation expectations over the medium term, in a manner conducive to achieving sustainable economic growth.

Since the past Inflation Report, a number of risk factors from those already identified have materialised, in particular those associated with new pay rises in the public sector (e.g. higher wages granted to public administration staff). Moreover, geopolitical tensions in the Middle East linger on, yet their direct economic effects are rather contained so far. Even in these conditions, the assessed balance of risks suggests possible upside deviations of inflation from its path in the baseline scenario, particularly in the case of new adverse supply-side shocks materialising.

The labour market features, reflected in the still relatively high tightness, continue to pose relevant risks to the inflation projection. Specifically, the swift wage dynamics economy-wide, induced by hikes in the minimum wage, fast pay rises in the public sector, but also by the strongly competitive labour markets, could trigger persistent inflationary pressure. In fact, high increases in unit labour costs have been recorded in the recent quarters and are also expected in the future. Against this background, wage increases significantly exceeding productivity growth economy-wide could be accommodated by firms only insofar as these costs would be, at least partially, passed on to consumers. In Romania’s economy, such a business approach could also be spurred by the persistent excess aggregate demand, which may further fuel strong inflationary pressures even amid the stabilisation of other inflation determinants, such as energy or food prices.

In this vein, the macroeconomic policy mix should be aimed at effective control of aggregate demand and, in particular, of the consumer demand component. In the model for analysis and medium-term forecasting, a synthetic indicator quantifying the excess pressures of aggregate demand is the output gap. A credible fiscal consolidation is needed in order to correct the excessive budget deficit and hence to calibrate a countercyclical fiscal policy that narrows the positive output gap. This implies structural reforms to enhance government revenues and, at the same time, exert stricter control over expenditures. By the time the baseline scenario of the projection was completed, the authorities had not announced either the dosage or the nature of the fiscal measures that could be adopted as of 2025: changes in direct or indirect taxes, measures for rationalising public spending, measures to boost revenue collection, etc. Moreover, according to information available in the public space, the possibility emerged, without being however firmly confirmed, that Romania would negotiate a fiscal adjustment plan extended over a longer period, up to seven years. Such a plan would directly imply, ceteris paribus, that the average annual fiscal consolidation effort would diminish accordingly. Strictly for this year, the busy electoral calendar does not rule out the risk of a fiscal slippage especially should new expansionary measures imply persistent increases in budget spending. In such a case, the starting point for the authorities’ multiannual endeavour to correct excessive budget deficits could be higher, implying that the entire future path of budget deficits would shift upwards as against the working assumptions in the baseline scenario (based on information that is certain at the time of completing the projection). Looking ahead, regardless of the source of excessive budget deficits, either higher government consumption expenditures, larger social transfers or more sizeable capital expenditures, the budget deficit correction is called for both in view of Romania’s commitments to the European Commission and for ensuring a balanced mix between the fiscal policy stance and the monetary policy stance over the medium term.

Although Romania and, more generally, Central and East European countries currently undergo an economic recovery, certain external factors, such as global inflationary shocks, tighter financial conditions or volatile energy prices, also due to geopolitical tensions, are significant risk sources. Hence, geopolitical risks – the war in Ukraine and, more recently, Middle East tensions –, which tend to become permanent, pose challenges to the smooth functioning of trade and investment flows. Any escalation of these tensions may weigh on trade routes, supply chains and already in place investment models, triggering significant disruptions to exports and imports and thus potentially generating stagflation risks (surging prices and, implicitly, higher inflation, together with stalling or even declining economic activity).

Monetary policy decision

In view of the significant improvement in the near-term inflation outlook versus the previous projection, but also amid the still elevated uncertainty surrounding forecasts over the longer time horizon, the NBR Board decided in its meeting of 7 August 2024 to cut the monetary policy rate by 0.25 percentage points to 6.50 percent. Moreover, it decided to lower by 0.25 percentage points the lending (Lombard) facility rate to 7.50 percent and the deposit facility rate to 5.50 percent. Furthermore, the NBR Board decided to keep the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions.

1. Inflation developments

The annual CPI inflation rate resumed its downward path in 2024 Q2, standing at 4.94 percent in June, i.e. 1.67 percentage points lower than three months ago. The disinflationary process was almost across the board, benefiting from the generally favourable conditions in commodity markets, from certain legislative changes that enabled a downward adjustment of utility prices, as well as from economic agents’ inflation expectations reverting to lower levels. Under these circumstances, adjusted CORE2 inflation declined considerably as well, down to 5.7 percent in June (-1.4 percentage points versus March), yet remained high, reflecting persistent pressures from labour costs and excess demand in the economy (Chart 1.1).

Exogenous components accounted for about half of the progress seen in CPI dynamics in 2024 Q2. After a year and a half in which electricity prices posted only minor changes and natural gas prices stayed unchanged, in April-June 2024 average utility prices decreased by 5 percent and 10.4 percent respectively compared to end-Q1. The auspicious conditions in the wholesale markets for natural gas and electricity, characterised by benign developments in domestic and European prices over the past year, enabled the adoption of some legislative changes essentially aimed at energy purchase costs[1], This refers to the decrease in the price at which producers sell without being overtaxed, from lei 450/ MWh to lei 400/MWh for electricity and from lei 150/MWh to lei 120/MWh for natural gas. which allowed for a drop in prices for household consumers of electricity and natural gas below the final price caps. Although during Q2 there was some volatility surrounding monthly changes (natural gas prices moved in both directions), the annual inflation rate for the electricity and natural gas segment fell to -7.2 percent in June 2024 compared to -0.4 percent at end-Q1 (Chart 1.2).

In June, fuel prices recorded marginally lower annual dynamics than those observed in March. Oil prices fluctuated strongly in this period, reaching a 2024 high in early April (over USD 90/barrel), amid escalating tensions in the Middle East. Subsequently, as the situation somewhat eased, the market rebalanced between USD 80 and USD 85 per barrel, inter alia as a result of industrial activity remaining sluggish worldwide and output exceeding the quotas announced by OPEC+ (Chart 1.3).

The adjusted CORE2 inflation rate declined at a pace close to that seen in 2024 Q1, falling to 5.7 percent in the last month of 2024 Q2; this time, however, all three groups contributed to disinflation to a relatively similar extent (Chart 1.4). The annual growth rate of processed food prices decelerated to 2.1 percent, further benefiting from the favourable conditions in the agri-food commodity markets (whose positive influence will likely fade out in the future, inter alia due to some adverse base effects). At the same time, the annual dynamics of volatile food prices (for vegetables, fruit, eggs) fell to -3.8 percent in June 2024.

Weather conditions in spring bolstered the adequate development of agricultural crops, but the outlook for this year’s harvest is overshadowed by the particularly high temperatures in June and July. Such extreme weather events have become common in recent years, and in the absence of appropriate countermeasures, climate change has the potential to raise inflation rates worldwide, as the frequency and intensity of its effects increase[2]. A recent paper estimates that global food inflation will go up, on average, by 0.9-3.2 percentage points per year until 2035, according to the current CMIP6 climate scenarios (Kotz, M., Kuik, F., Lis, E. and Nickel, C., “Global warming and heat extremes to enhance inflationary pressures”, Communications Earth & Environment 5, 2024).

Disinflation sped up in the non-food and services segments compared to the previous quarters (8.6 percent and 8.0 percent respectively in June). The developments reflect the relatively favourable context in terms of input costs of materials (decelerating IPPI for most consumer goods industries), milder inflationary influences from import prices – both having a relevant impact on non-food prices –, but also the softer demand for market services. However, the monthly dynamics in 2024 Q2 remain high for the two groups – core momentum, determined by using the seasonally adjusted monthly rates in Q2, was 6.2 percent for non-food items and 5.1 percent for market services. Factors such as the pressure from wage costs and excess demand continue to hinder the disinflationary process of these components, putting core inflation on a slowly downward trajectory.

In 2024 Q2, short-term expectations on price developments underwent a correction for all economic agents (with trade posting the highest decreases in the balance of answers), once the sentiment generated by the fiscal measures at the beginning of the year faded out (Chart 1.5). Similarly, financial analysts’ expectations on the inflation rate over the one-year and two-year horizons were revised downwards, the latter standing even below the upper bound of the variation band of the flat target, according to the July 2024 survey.

The average annual inflation rate further declined in 2024 Q2, falling to 7.2 percent for the indicator calculated based on the national methodology and to 7.3 percent for that calculated in accordance with the harmonised structure (-1.3 percentage points and -1 percentage point respectively compared to end-2024 Q1). The differential against the EU average remained close to that posted at the end of the previous quarter, i.e. 3.7 percentage points (Chart 1.6).

At end-2024 Q2, the annual CPI inflation rate fell 1.1 percentage points below the forecast shown in the May 2024 Inflation Report, mainly due to the unexpected developments in the prices of electricity and, particularly, of natural gas, as well as to the correction of the Brent oil price.

2. Economic developments

1. Demand and supply

In 2024 Q1, annual economic growth slowed down to 0.5 percent[3] In this section, the analysis of the annual change in GDP relies on the volume series expressed in the prices recorded in the corresponding quarter of the previous year. (as compared to 3 percent in 2023 Q4). This was primarily due to the setback in construction investment and the stronger negative contribution of net exports (Chart 2.1).

Amid the rise in household real income, consumer demand continued on an upward trend, posting an annual rate of increase of 3.4 percent in 2024 Q1 (faster by almost 1 percentage point as against 2023 Q4). Apart from higher permanent income, the household final consumption expenditure was also supported by borrowed funds (amid the improved lending conditions), the additional flows reflecting mainly in purchases of non-food items – solid growth rates were recorded by sales of furnishings, wearing apparel and footwear, pharmaceutical and cosmetic products, as well as by the automotive trade (quarterly change[4] The reduced dynamics in annual terms (1 percent) are ascribed to a statistical effect – the persistent influences from global supply chain disruptions resulted in a substantial rise in purchases of motor vehicles at the beginning of the previous year (as firms worked off large order backlogs). on a rise to 3.1 percent). Food sales increased too (1.7 percent), even though consumers remained cautious when selecting and purchasing goods. On the supply side, retailers showed further interest in investment in streamlining and digitalisation, along with the expansion of networks.

Household consumption will probably preserve its positive dynamics in the coming period, in view of the improvement in consumer confidence indicator (up 3.7 points in 2024 Q2 versus the Q1 average), as a result of households’ brighter expectations of the general economic situation and the individual financial position in the next 12 months (Chart 2.2). The increase in consumer confidence can be ascribed to the optimistic income expectations (associated with the measures planned for Q2 and Q3 to raise the minimum wage, the wages of selected categories of public sector employees, and pensions), in parallel with ongoing disinflation. However, a deceleration in consumption growth is not ruled out over the short term, as suggested by retailers’ declining optimism about the volume of receipts from goods sales and particularly from market services to households. Actual data on the turnover volume inApril-May 2024 confirm these expectations – the volume of goods purchases posted a slower growth (approximately 1 percent as compared to the previous quarter’s average), while that of market services to households contracted by 3.7 percent, the demand in this sector being dampened by the still high price dynamics.

In 2024 Q1, the general government budget execution led to a deficit of lei 35.9 billion (2.0 percent of GDP), well above that posted in the same period of 2023 (lei 22.8 billion, i.e. 1.4 percent of GDP), yet it was also atypically slightly higher than that recorded in 2023 Q4[5]. In 2023 Q4, the negative balance of the budget stood at lei 33.4 billion (2.1 percent of GDP). The pick-up from the previous quarter was ascribable to total budget spending[6], This posted a significantly faster real annual growth rate, i.e. up to 14.6 percent, from 4.0 percent in the previous quarter. which witnessed an unusually small decline according to the intra-annual pattern of budget execution[7], Even amid the marked decrease in spending on projects financed from non-repayable external funds, but which only had a relatively minor effect on budget balance, owing to the similar evolution of disbursements from the EU. The decline in this expenditure category was sharper than in the same year-ago period, due to the base effect associated with the high level recorded in 2023 Q4. Its real annual dynamics, albeit on the wane, remained high, significantly above those of total budget expenditure. amid the modest decrease in capital expenditure[8] This tripled in real annual terms, after the contraction witnessed in the last three months of 2023 as a whole. and in spending on goods and services[9], Its annual dynamics re-entered positive territory in 2024 Q1. as well as due to an increase in other current expenditure[10]. Namely in social security spending – whose real annual growth accelerated, inter alia amid the rise in the pension point and in payments for the compensation for the electricity and natural gas bills –, as well as in spending on subsidies, which nevertheless continued to contract in annual terms. The developments in total budget revenues had an almost neutral influence, given that their decrease[11], Their real annual growth rate slowed down to 8.1 percent (from 11.3 percent in the previous quarter), by contrast with that of expenses, yet on the back of the slower dynamics of disbursements from the EU, which however remained high. while somewhat higher than that of expenses, was almost entirely driven by disbursements from the EU – which have a relatively small impact on the change in budget deficit –, and the decline in tax revenues in this period[12] This drop was nevertheless more modest than in the same year-earlier period, and their real annual dynamics returned to positive territory, largely on account of the rebound in receipts from corporate income tax and the tax on use of goods. was more than offset by the increase in receipts from social security contributions[13]. The increase also reflected the impact of some measures applied in the previous quarter, consisting in the removal of sectoral tax breaks, as well as in the rise in the gross minimum wage economy-wide and in some business sectors.

Budget execution further deteriorated in 2024 Q2, the deficit recorded in this period, i.e. lei 27.8 billion (1.6 percent of GDP) being almost double than that in 2023 Q2 (lei 14.5 billion, i.e. 0.9 percent of GDP).

Thus, in 2024 H1 as a whole, a budget deficit of lei 63.7 billion (3.6 percent of GDP) built up, substantially higher than that posted in the same year-ago period, amounting to lei 37.2 billion (2.3 percent of GDP).

Gross fixed capital formation was the main contributor to the slowdown in economic growth. The decline to 7.1 percent in its annual dynamics was primarily ascribed to the halt in the upward trend of construction, whereas equipment purchases kept rising at a swift pace (16.7 percent, decelerating mildly as against 2023 Q4). The annual rate of change of investment may remain positive in the short run, but a step‑up is little likely. On the one hand, as regards the financing from non-repayable EU funds, capital investment in 2024 is influenced by an unfavourable base effect (in 2023, the eligibility period of spending under the 2014-2020 MFF ended), as well as by the delayed absorption of funds allocated under the new MFF. Specifically, unlike the previous MFF, in which investment funds virtually started to be absorbed in the third year (the amounts raised doubling as compared to the previous two years), in 2024 (the fourth year of the current MFF) the modest performance seen in the previous years seems to continue, as suggested by the H1 data on the absorption of investment funds (this evolution could be counterbalanced, to a certain extent, by the disbursement, at least in part, of the third payment request under the NRRP). On the other hand, the net FDI inflows in the form of equity[14] Including the estimated value of reinvestment of earnings. do not seem either to be indicative of a pick-up in investment in the near future, as they stagnated in annual terms in January-May 2024. Signs of moderating investment dynamics also come from an AHK[15] German-Romanian Chamber of Commerce and Industry. survey conducted this spring – as compared to the opinions expressed in the 2023 survey, the share of German investors with intentions to increase investment in the following 12 months shrank from 40 percent to 34 percent, while that of respondents stating they would maintain their investment volume expanded to 46 percent.

Investment in construction remained unchanged at the level recorded in 2023 Q1 (after an annual advance of 23.8 percent in 2023 Q4[16]), According to national accounts data on gross fixed capital formation. due to a base effect (quarterly growth of 5 percent in January-March 2023), as well as to a 1.6 percent decrease in the reviewed quarter. However, current developments seem uncorrelated with the perception of construction companies, the DG ECFIN confidence indicator in Q1 standing at a level similar to the averages for the previous two quarters. Moreover, looking at the monthly volume indices of construction works, the contraction is solely ascribed to January developments (monthly change of -36.4 percent, followed by successive rebounds in the next months). Thus, the conclusion that arises is that the Q1 decline in investment in construction may be rather ascribed to a statistical effect, the monthly series being likely disrupted by the change of the base year and, implicitly, of the weighting coefficients for sub‑indices (in January 2024). The breakdown shows that the two main segments will probably continue to see diverging developments – positive dynamics of civil engineering works (also spurred by the electoral agenda) and the ongoing subdued prospects in the market of new real estate projects, especially in the residential segment, further affected by supply constraints. Specifically, alongside the dampening effects exerted by the resumed upward trend in costs of materials and by the uncertainty surrounding the timeline for the Zoning Code adoption, the construction of buildings is affected by the shortage of skilled labour, given the robust demand for workers in civil engineering works (Chart 2.3).

Turning to the machinery and equipment purchases, market signals hint at the continuation/completion of several greenfield investment projects in 2024, insub-sectors such as the manufacture of rubber products, building materials, the food industry, pharmaceuticals, research and development and the manufacture of parts for household appliances and industrial equipment. Adding to these are investments in (i) transition to a green economy, including the construction of a plant to manufacture electricity storage systems for residential, commercial and industrial areas, as well as electric car batteries; (ii) installation of three storage units under the first project of a fully automated, hybrid solar-wind battery system (the first storage unit was commissioned in Q2, using domestically-produced batteries); (iii) launch into production starting 2024 of three fully electric motor vehicles manufactured in Romania. In the defence sector, projects are underway for the expansion and technological upgrading of three production facilities no longer in use, with the contribution of foreign investors (Chart 2.4).

Net external demand was also a driver of the slowdown in real GDP advance in Q1, making a stronger negative contribution of -2.5 percentage points, amid the worsening of the balance on trade in goods (Chart 2.5). In the latter case, a trend reversal is little likely to occur in the immediately forthcoming period, given that the gradual rebound in exports (in line with the mild recovery of European economies) will be accompanied by positive dynamics of imports, supported by the domestic demand for final goods and inputs for industry.

In 2024 Q1, the volume of exports of goods rose marginally by 0.1 percent in annual terms. Exports were on a rise in annual terms in manufacturing sub-sectors such as petroleum products, rubber, non-metallic mineral products, basic metals, machinery and equipment (real annual growth rates of turnover on the external markets ranging between 3 percent and 22 percent); at the opposite pole remained sub-sectors such as the light industry, furniture, electronic products and electrical equipment. Moreover, the 2023 satisfactory crops led to an additional rise in the net exports of agri‑food commodities (by 44 percent, volume change) and probably helped improve the trade balance on some food items (vegetable oil, milling and bakery products)[17]. Calculations based on international trade data – Classification of Products by Activity (CPA) (Source: Eurostat).

Imports of goods gained momentum in annual terms (to 1.6 percent), due to developments in the segment of consumer goods (in correlation with the increase in demand) and particularly in that of intermediate goods. In the latter case, the recovery of energy-intensive industries (chemicals[18], Due inter alia to Azomureș resuming activity (in a proportion of 50 percent) at end-January. metallurgy, other non-metallic mineral products) entailed higher demand for inputs, especially natural gas[19] Import prices were more advantageous, the domestic gas stocks being stored at higher prices. and coke products, iron ore, ammonium and mineral products for the chemical industry, primary products for the manufacture of building materials.

The negative differential between the dynamics of goods export volume and those of goods import volume was offset by the favourable evolution of the price component (UVI of imports saw a sharper decrease than that of exports)[20]. Calculations based on international trade data – standard international trade classification by broad economic categories (BEC) (Source: Eurostat). Consequently, according to the balance of payments, the deficit on trade in goods continued on the same trend as in 2023, contracting in Q1 as well, but only by 1.5 percent. The downward path reversed in April-May (on account of the pick-up in import dynamics), so that the goods deficit widened by 13.1 percent January through May 2024 versus the same year-ago period. This affected the current account deficit (+33.4 percent), to the rising external imbalance also contributing the lower services surplus[21] Resulting from the widening shortfall of travel and air transport, as well as from the relative decline in net receipts from ICT and goods produced under processing arrangements. and the higher primary income deficit, as a result of increases in dividend payments and reinvested earnings (estimated values) of FDI enterprises, as well as in the yields on government securities issued on the external market (Chart 2.6).

Labour productivity

Labour productivity economy-wide declined considerably in 2024 Q1 (-3.3 percent annual rate of change versus 2.7 percent in 2023 Q4)[22], The sectoral analysis of productivity indicators based on national accounts data is hampered by the significant fluctuations in data series on employed persons: their dynamics stepped up markedly in construction and ICT in 2024 Q1, which is at odds with the message conveyed by monthly series. Chart 2.7. In industry, the indicator followed a winding path in early 2024. Specifically, while in January it seemed to have reached a turning point, as it subsequently re‑entered a trajectory that hinted at a rebound in activity, the data for April-May indicated a renewed contraction in production and productivity indicators, amid the difficulties marking the recovery of Europe’s industrial sector. January through May 2024, labour productivity in industry shrank by 2.3 percent overall. Its further path will likely be uneven, the relevant indicators providing a mixed picture of the sector’s prospects.

Traction from external demand improved only slightly. New foreign orders fell by 4.1 percent in annual terms in 2024 Q1, after being stagnant in 2023 and having declined before as well; it was only in April that the annual rate of change re‑entered positive territory. At the same time, the euro area manufacturing Purchasing Managers’ Indices (PMIs) remained in contractionary territory, just as in the past two years (45.8 points in June). On the domestic side, in 2024 Q1 the capacity utilisation rate decreased to 68.9 percent from an already relatively low level from a historical perspective, while the short-term confidence indicator in the DG ECFIN survey has increased marginally of late, yet solely to a level close to nil (Chart 2.8).

Nonetheless, domestic demand was further robust, marking the fourth successive quarter of growth in annual terms in early 2024. At the same time, the manufacturing PMI for Romania rose noticeably in Q2 and investment in production capacities provides reasons to be optimistic. Apart from the recent developments in previously mentioned investments, an increasingly large number of foreign investors[23] According to the spring edition of FIC (Foreign Investors Council) Members Business Sentiment Index. consider Romania more attractive than peer countries in terms of implementing potential new investment projects.

Actions influencing trade relations with China are a determinant of the future industrial performance of  the EU as a whole. The European Commission approved, as of 5 July 2024, a substantial increase in import tariffs on electric vehicles (EV) made in China, with a view to protecting EUhome-grown manufacturers from the Beijing‑subsidised EV production, which is subsequently exported to the EU market at highly competitive prices (a final decision on the permanence of these tariffs will be taken in November). For now, China’s first reaction has been to launch targeted anti-dumping investigations into some processed food items originating in the EU[24]. Prohibitive measures may be implemented for products that expose the EU more to China due to the volume of exports involved, such as meat, alcoholic drinks, internal combustion engine cars, aircraft, luxury goods, pharmaceuticals and cosmetics. The escalation of trade tensions and the intensification of protectionist measures on both sides have the potential to adversely affect the recovery of industrial activity in Europe and, implicitly, in Romania.

Labour market developments

The weakening of economic activity in early 2024 did not translate into a worsening of labour market conditions. The job vacancy rate stabilised, being accompanied by a decline in the unemployment rate, while the number of employees continued to increase, yet at a markedly slower annual pace. At the same time, the growth rate of wages remained fast in the private sector (yet slightly on the wane) and particularly in the budgetary sector, where the trend is expected to persist over the short term, given the government’s loose income policy.

The annual rate of change of the number of employees economy-wide was further positive, but it continued to slow down to 0.9 percent in Q1 and 0.7 percent in April‑May 2024 (from 1 percent in 2023 Q4). Behind the deceleration stood mainly services, especially the ICT sector, marked by cuts in payrolls internationally, and business services as well. Construction also posted a slightly slacker pace of hiring, which remained nonetheless higher than that recorded economy-wide (at approximately 2 percent), amid the large infrastructure projects under way. In industry, headcount further stood still, most sub-sectors witnessing modest payroll increases, while faster paces of hiring were somewhat isolated (in food and beverages, the manufacture of paper, of pharmaceuticals, of fabricated metal products and of other transport equipment). Trade reported a rebound in payrolls (particularly in April‑May, a period marked by Easter celebrations), in correlation with the rise in economic activity seen since early 2024. In the budgetary sector, the dynamics of the number of employees slowed down to 0.9 percent in Q1 and in April-May from 1.2 percent at end-2023, Chart 2.9.

The results of the DG ECFIN survey on employment are indicative of an increase in labour demand in the short run, the Employment Expectations Indicator running at 107.2 points in 2024 Q2 (up 1.3 points from the previous quarter), but the rigidity of labour supply might act as a deterrent. At sectoral level, solely trade and services posted robust employment intentions, whereas in industry the indicator fell deeper into negative territory, suggesting downsizing; in construction, the more upbeat outlook in April reversed over the following two months, the Q2 average standing at 0.1 points, below the already modest level in the previous three-month period.

The job vacancy rate stabilised at 0.7 percent in 2024 Q1, concurrently with a more pronounced decline in the ILO unemployment rate, to an average of 5.3 percent for January-May 2024 (from 5.6 percent in 2023 Q4), which is indicative of a certain increase in labour market tightness. At the same time, according to the latest DG ECFIN survey, the share of companies citing labour shortage as a factor that constrains their activity rose slightly in 2024 Q2, this affecting primarily the construction activity (Chart 2.10).

The annual growth rate of the average gross wage economy-wide stepped up to 16.7 percent in 2024 Q1 (+0.3 percentage points from 2023 Q4), before decelerating to 16.1 percent in April-May.

The pick-up in the first three months of 2024 was driven solely by the developments in the budgetary sector, where the annual growth rate surged to 19.6 percent in Q1 and further to 20.3 percent in April-May (from 16.4 percent October through December 2023), following a new round of pay rises in education, but also some wage increases for healthcare staff. By contrast, private sector wage dynamics slowed down from 16.4 percent in 2023 Q4 to 15.9 percent in 2024 Q1 and 15 percent in April‑May, gradually mirroring the declining influence of inflation expectations and the ever lower support from labour productivity. In fact, the specifications of the wage Phillips curve that explain wage developments based on fundamentals have captured, as of late 2023, the significant and rising role of exogenous factors, associated with the government’s income policy, characterised by successive increases in the minimum wage and in budgetary sector wages (Chart 2.11).

2. Import prices and producer prices on the domestic market

In 2024 Q1, given the relatively favourable conditions in commodity markets, import prices as well as industrial and agricultural producer prices further recorded negative annual dynamics. For the latter, the decline continued through April and May as well, yet a trend reversal is not ruled out in the period ahead, as a number of prices have resumed their upward path.

2.1. Import prices

Against the backdrop of improved prospects for industrial activity worldwide and of escalating geopolitical tensions in the first part of 2024 Q2, the aggregate commodity price index calculated by the World Bank reversed its trend, recording a 4.6 percent annual increase, following a 6.8 percent contraction in 2024 Q1 (Chart 2.12).

Specifically, the annual dynamics of energy prices returned to positive territory (4.9 percent), after standing at -7.7 percent in the first three months of the year. The breakdown shows that the Brent oil price followed a gradual upward path in the first months of 2024, amid heightening geopolitical tensions in the Middle East, climbing to over USD 90 per barrel in April as the conflict between Iran and Israel aggravated. Once this episode passed, the Brent oil price shifted to somewhat lower levels, which, however, still exceeded USD 80 per barrel overall.

On the European natural gas market storage levels remained high. Nevertheless, a number of issues related to the supply of liquefied natural gas (LNG)[25] Robust demand from Asian economies limited the supply available for Europe. and the risk of a discontinuation of deliveries from Russia to the EU[26] As a result of legal disputes that block payments from European companies. fuelled prices to re-embark on an upward path, their annual change coming in at -11.5 percent in 2024 Q2 versus -48 percent in 2024 Q1.

Metal prices largely posted steady developments during 2024 Q1, their values remaining below those recorded in the first part of 2023. However, in 2024 Q2, their annual dynamics returned to positive territory, exceeding 9 percent and peaking in May, due to supply-related concerns, to the signs at that time of a recovery in global industrial activity boosted by the expansion of the renewable energy sector, as well as to the announcement of support measures for the residential sector in China. Towards the end of the quarter, the large stocks of aluminium and the expansion of related production in China fostered the slowdown in the growth rate of these prices, with similar developments being observed in iron ore, as Australia’s exports have increased significantly and China intends to reduce steel production amid the shrinking domestic demand.

Turning to agri-food commodities, pressures remained relatively low, yet the annual contraction in these prices moderated from 9.4 percent in 2024 Q1 to 4.3 percent inApril-June, due to less optimistic expectations regarding the global harvest. The breakdown shows that the trend was broad-based, except for sugar, where output estimates are favourable.

The movements in commodity prices during the first months of 2024 were also seen in import prices. Specifically, in 2024 Q1, the unit value index (UVI) of imports remained below one (95.7 percent), dropping by 2.6 percentage points from 2023 Q4, while the groups of goods with sub-par or declining UVIs as compared to the previous quarter became prevalent. This trend was also visible for most imported goods holding a share in the CPI basket, including both food items (e.g. meat, sugar, fats) and non-food items (the UVI of imports of transport equipment fell below one, after two and a half years of values showing increases).

2.2. Producer prices on the domestic market

In April-May 2024, the annual rate of decline of industrial producer prices on the domestic market slowed down compared to 2024 Q1, adding 5.4 percentage points to reach -4 percent (Chart 2.13). Energy prices made a decisive contribution thereto, owing, however, to a statistical effect, considering that current developments point to declines similar to those seen in the preceding period. Producer prices for intermediate goods also recorded a milder contraction in annual terms, as metal prices were boosted by signals of economic recovery in China, but also by the sanctions that the  US and the UK imposed on Russia (with a potential supply-side effect). Conversely, the annual rate of change of producer prices for consumer goods remained on a downward path for the time being, but a turning point cannot be ruled out, given that some prices resumed their upward movement in 2024 Q2.

No significant changes in the dynamics of producer prices are expected for the period ahead, with the balance of answers in the DG ECFIN survey for 2024 Q2 standing slightly below the level recorded in 2024 Q1. Nonetheless, pressures could arise from natural gas and electricity prices.

The annual rate of decline of energy prices eased by 8.7 percentage points April through May compared to 2024 Q1, up to -10.8 percent, shaping the path of producer prices on the domestic market at an aggregate level. These dynamics were determined by a statistical effect; in April-May 2024, in line with developments at the European level, spot prices for natural gas and electricity on the domestic wholesale markets remained at modest levels, given that consumption was still low amid a merely gradual and volatile recovery of industrial activity. The newly-operational solar power production facilities drove prices into negative territory during specific time intervals in April 2024, but these developments have had a limited impact, as the construction of electricity storage systems is still in its early stages. Nevertheless, starting in the latter part of the period under review, energy producer prices on the domestic market have followed external trends and have increased, owing, inter alia, to some unfavourable influences from the domestic supply (such as the drought-hit hydro power output, and the overhaul at Nuclearelectrica). Crude oil processing prices picked up in annual terms, yet, once again, the movement was the result of statistical effects, as the hike in prices reported in April 2024 was followed by a sharp fall a month later, amid the easing of the oil market.

Similar, albeit more moderate developments were recorded by producer prices for intermediate goods, whose annual dynamics reached -3.1 percent in April and May overall (+2.8 percentage points). The chemical and basic metal industries posted slower negative annual rates of change, the latter being affected by rising metal prices, despite the opposite influence coming from further weak domestic demand.

The annual dynamics of producer prices for capital goods, although slightly on the wane (-0.5 percentage points), remained at high levels, i.e. 7.7 percent, well above the industrial sector’s average, a situation that is expected to persist due to the rise in metal prices.

The annual growth rate of producer prices for consumer goods continued to decelerate April through May (-0.8 percentage points to 4.0 percent), solely on account of non‑durables. In the food industry, producer prices fell by 0.3 percent in annual terms, staying on the relatively stable path they had embarked on in mid‑2023, as pressures on agri-food commodity markets are still contained. The annual growth rate of producer prices for consumer goods excluding food, beverages and tobacco hovered around 6.5 percent this year.

In April-May 2024, agricultural producer prices continued to exhibit negative annual rates of change (-11 percent), albeit less pronounced, due to the slower pace of decline in prices for vegetal products (up to -15.1 percent), Chart 2.14. Considering the less favourable outlook for global agricultural supply and the tendency of domestic prices to align with external developments, this upward trend may continue. As for prices of animal products, the drop in their annual pace of increase to nearly zero (from 1.6 percent in 2024 Q1) was underpinned by all varieties of meat and was associated with some favourable base effects, as well as with the rise in domestic output compared to the same period of the previous year.

Unit labour costs

The annual dynamics of unit labour costs economy‑wide soared in 2024 Q1 to 21.6 percent (compared to 15.4 percent in the previous quarter), as the slowdown in economic activity was not accompanied by employment or compensation adjustments. Thus, labour productivity shed 3.3 percent in annual terms, while the pace of increase of compensation per employee, albeit slower, remained fast (17.6 percent, -0.9 percentage points from 2023 Q4), further generating inflationary pressures (Chart 2.15).

In industry, the annual growth rate of unit wage costs declined to 14.4 percent in April‑May, from 18.1 percent in the previous two quarters. The outlook for domestic output stays relatively subdued, at least until external demand strengthens more visibly. At the same time, labour force saw no significant adjustments compared to the previous quarters: payrolls remained largely unchanged, while the pace of increase of wages was further brisk, albeit slightly losing momentum (13.7 percent inApril-May, from 14.1 percent in Q1 and 16.3 percent in 2023 Q4). The moderation in the dynamics of unit wage costs was almost across the board, with some industries still recording high increases (above 20 percent), i.e. beverages, crude oil processing, manufacture of rubber and plastic products and manufacture of electronic products.

3. Monetary policy and financial developments

1. Monetary policy

The NBR extended the status-quo of its key rates in May 2024, before lowering by 0.25 percentage points in July the monetary policy rate, to 6.75 percent, as well as the lending facility rate and the deposit facility rate, to 7.75 percent and 5.75 percent respectively (Chart 3.1). The central bank kept the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions at 8 percent and 5 percent respectively. The decisions aimed to ensure and maintain price stability over the medium term, in line with the 2.5 percent ±1 percentage point flat target, in a manner conducive to achieving sustainable economic growth.

The NBR Board decisions in May were taken in a context in which, after the step-up recorded in January 2024, the annual inflation rate fell slightly, returning in March to the end-2023 level, still considerably above the variation band of the target. Moreover, the new medium-term forecast reconfirmed the outlook for the annual inflation rate to go down over the following eight quarters at a much slacker pace compared to 2023, and even somewhat more slowly in the short run than previously anticipated.

Specifically, the annual inflation rate declined in small steps after the January rise, reaching in March a level similar to that seen at the end of the previous year, i.e. 6.61 percent[27]. From 7.23 percent in February. This reflected the relatively equal opposite effects generated in Q1, on the one hand, by the faster dynamics of electricity, fuel and tobacco product prices – amid a base effect, the hikes in excise duties and higher crude oil prices – and, on the other hand, by the reduction in core inflation and in the dynamics of VFE prices. In turn, the deceleration in adjusted CORE2 inflation slowed down in the first three months of the year compared to the previous two quarters. Its annual rate fell to 7.1 percent in March[28], From 8.4 percent in December 2023. Behind the deceleration stood, in this period as well, disinflationary base effects, downward adjustments in agri-food commodity prices and the measure to cap the mark-ups on basic food products, alongside the slower dynamics of import prices. A moderate opposite impact had the direct and indirect effects of the fiscal measures implemented at the beginning of 2024 and the higher short-term inflation expectations, as well as the new increases in wage costs recorded towards the end of the previous year, which were passed through, at least in part, into the prices of some services and goods, inter alia amid the rebound in private consumption. given that disinflation lost momentum particularly in the food segment, but also in the case of non-food and services prices, the annual dynamics of which were still very high.

At the same time, the new medium-term forecast reconfirmed the outlook for the annual inflation rate to decrease across the projection horizon much more slowly compared to 2023, but also on a somewhat higher path in the short run than that shown in the February projection. Specifically, the annual inflation rate was expected to decline to 4.9 percent in December 2024, versus the previously-anticipated 4.7 percent, and to fall only marginally inside the variation band of the target at the end of the projection interval, i.e. to 3.4 percent in March 2026, in line with prior forecasts.

The decrease was anticipated to be further driven primarily by supply-side factors. However, their disinflationary action would weaken progressively and more markedly over the short term than in the previous projection, given the softening influences expected from base effects and from downward corrections of agri-food commodity prices, but also amid the relatively higher dynamics anticipated in the fuels and tobacco products segments over the following quarters. Moreover, the evolution of crude oil and other commodity prices remained a source of inflationary risks, at least in the short run, especially in the context of geopolitical tensions.

Underlying inflationary pressures were anticipated to persist and abate only slightly throughout the forecast horizon, as previously forecasted, given the prospects for excess aggregate demand to narrow very slowly over the next eight quarters and remain significant at the end of the projection interval[29]. Having as underlying premises the prospects for economic growth to record a progressive acceleration in 2024 and 2025, and somewhat more pronounced than previously anticipated, amid the slowdown in inflation and the gradual recovery of external demand, but especially in the context of the fiscal policy stance and the use of EU funds under the Next Generation EU instrument. Furthermore, the increase in unit labour cost was expected to moderate only mildly during the current year, remaining visibly more alert than in the prior projection.

At the same time, heightened uncertainties and risks were associated with the fiscal and income policy stance, stemming in 2024 from the outcome of the budget execution in the first months of the year, the public sector wage dynamics and the full impact of the new law on pensions. Beyond this horizon, heightened risks were however linked to the fiscal and budgetary measures potentially implemented in the future to carry out the fiscal correction and to put the budget deficit onto a sustainable downward path, compatible with the requirements of the excessive deficit procedure and with the conditionalities attached to other agreements signed with the EC.

Nevertheless, uncertainties and risks to the outlook for economic activity, implicitly the medium-term inflation developments, also continued to arise from the war in Ukraine and the Middle East conflict, alongside the economic performance in Europe, as well as from the absorption of EU funds, especially those under the Next Generation EU programme, given the attached conditionalities.

According to subsequently-released statistical data, the annual inflation rate saw a faster decline in the first two months of 2024 Q2, falling to 5.12 percent in May, below the forecast, mainly as a result of the notable drop in energy prices, especially natural gas prices, following the legislative changes implemented as of April, as well as amid the further deceleration in the growth rate of food prices. The annual adjusted CORE2 inflation rate continued to decrease gradually, in line with expectations, down to 6.3 percent in May, as the pace of disinflation slowed down even more in the processed food segment, but remained unchanged in the non-food segment and stepped up slightly in the case of services, the annual growth rates of which were, however, still high.

The main drivers behind the developments in core inflation continued to be, over this period as well, the disinflationary base effects and the downward corrections of commodity prices, which were nevertheless fading in the processed food segment, but extended and strengthened across the non-food sub-components of core inflation. Additional influences stemmed from the decreasing dynamics of import prices, as well as from short-term inflation expectations re-embarking on a slight downtrend. A moderate opposite impact had the new increases in unit labour costs recorded in the first months of 2024, which were passed through, at least in part, into the prices of some goods and services, inter alia amid a robust consumer demand that increased strongly in April.

Economic activity rebounded in 2024 Q1 to a lower extent than anticipated, up by 0.4 percent, after its 0.6 percent contraction in 2023 Q4, which made it likely for excess aggregate demand to have further narrowed over this period, contrary to expectations. At the same time, annual GDP growth contracted markedly in Q1, to 0.1 percent from 3.0 percent in the previous three months. The loss of momentum was driven this time round mainly by gross fixed capital formation, whose annual dynamics plummeted from the very high two-digit level seen in 2023 Q4, whereas household consumption continued to witness a faster annual growth. Net exports exerted a larger contractionary influence in 2024 Q1, against the backdrop of a slight pick-up in the differential between the positive dynamics of the import volume of goods and services and the further negative change in the export volume. However, the growth rate of the trade deficit remained unchanged, while that of the current account deficit decreased considerably from the previous quarter, given inter alia the strongly faster increase in the secondary income surplus during this period, mainly on account of inflows of EU funds to the current account.

Looking at the labour market, the latest data and surveys confirmed a halt in the easing of market conditions in 2024 Q1, given also the relatively flat job vacancy rate. Moreover, they showed that in April the number of employees economy-wide resumed its monthly increase at a swift pace, while the ILO unemployment rate advanced only slightly in April-May to 5.4 percent, after a more pronounced drop in Q1, remaining below the average 5.6 percent level seen over the last two quarters of the previous year. At the same time, employment intentions over the very short horizon followed a steeper upward trend in Q2 overall, their substantive drop in June notwithstanding, while the labour shortage reported by companies widened again this quarter. In addition, the double-digit annual growth rate of the average gross nominal wage continued to rise in Q1, before remaining unchanged in April. In turn, the annual dynamics of unit wage costs continued to climb in the first three months of the year economy-wide, being further particularly elevated in industry during Q1, while the steep decline in the latter in April owed mainly to a calendar effect.

On the financial market, the main interbank money market rates remained quasi‑stable in May and posted slight declines afterwards, while the average lending rate on new business continued to shrink sizeably in April and May, albeit more modestly than in March. Long-term yields on government securities witnessed a moderate downward adjustment in mid-Q2, but then climbed and stuck to the higher readings seen in April. This occurred inter alia amid the fluctuation of investor expectations on the outlook for the Fed’s interest rate, as well as in view of the political events in Europe, which entailed shifts in global financial market sentiment and in the risk perception towards the region.

Against this background, the EUR/RON exchange rate stayed in May-June at the higher levels it had returned to in the second part of April. In relation to the US dollar, the leu recovered in May the loss seen in the previous month, before weakening again in June, amid the former’s strengthening on international financial markets.

The annual growth rate of credit to the private sector picked up to 5.8 percent in April, after having fallen to 4.7 percent in March, while in May it stood at 5.7 percent. This reflected the further swifter increase in household credit during this period, mainly on account of consumer loans in domestic currency[30]. Whose flow reached a historical high in April and diminished only slightly in May. Conversely, the annual dynamics of loans to non-financial corporations stuck to a downward path, prompted by the decrease in the rate of change of the leu-denominated component[31]. Counterbalanced to a small extent in terms of impact by the upward dynamics of the sector’s foreign currency credit. The share of leu‑denominated loans in credit to the private sector narrowed marginally to 68.8 percent in May from 68.9 percent in March 2024.

Against this backdrop, the new assessments showed that the annual inflation rate would continue to decline over the following months, on a significantly lower path than that shown in the May 2024 medium-term forecast. The decrease would be further driven primarily by supply-side factors, whose disinflationary action would remain stronger in the near run than previously anticipated, amid the influences from base effects and from legislative changes in the energy sector implemented as of April. These influences would reflect particularly in the energy, administered prices and fuel segments, but also at the level of non-food items and services sub‑components of core inflation. Moreover, they would be counterbalanced only to a small extent by the rebound envisaged in food price dynamics, under the impact of unfavourable base effects and the uptrend in some agri-food commodity prices.

Significant uncertainties were, however, associated with the impact exerted in the future on natural gas and electricity prices by the legislative changes applied in April, as well as with the prospective evolution of crude oil and other commodity prices, especially in view of geopolitical tensions.

Furthermore, underlying inflationary pressures were likely to be somewhat stronger in the near run than in the prior forecast, given that the new assessments indicated significant quarterly increases of the economy in 2024 Q2 and Q3, and more solid than previously anticipated[32], Implying a gradual recovery of annual GDP dynamics during the two quarters, after the steep decline in Q1. implying a rise in excess aggregate demand during this period slightly above the values envisaged in May 2024, after the unexpected contraction in Q1. At the same time, the annual dynamics of unit labour costs were seen sticking to a very high two-digit level, while increasingly visible disinflationary effects were anticipated over this time horizon from the slacker growth rate of import prices and from the gradual downward adjustment of short-term inflation expectations.

Heightened uncertainties and risks further stemmed from the future fiscal and income policy stance, given on one hand the budget execution in the first five months of the year, the public sector wage dynamics and the full impact of the new law on pensions, and on the other hand the fiscal and budgetary measures that could be implemented in the future to carry on budget consolidation.

Nevertheless, uncertainties and risks to the outlook for economic activity, implicitly the medium-term inflation developments, continued to arise also from the war in Ukraine and the Middle East conflict, from the economic performance in Europe, as well as from the absorption of EU funds, especially those under the Next Generation EU programme.

This context, characterised by a decline in the annual inflation rate on a significantly lower path than previously anticipated, in the near run as well, but also by still elevated uncertainty surrounding developments over the longer time horizon, warranted a prudent lowering of the monetary policy rate, with a view to ensuring and maintaining price stability over the medium term, in a manner conducive to achieving sustainable economic growth.

Thus, in its meeting of 5 July 2024, the NBR Board decided to cut the monetary policy rate by 0.25 percentage points, to 6.75 percent. Moreover, it decided to lower the lending facility rate and the deposit facility rate also by 0.25 percentage points each, to 7.75 percent and 5.75 percent respectively. At the same time, the NBR Board kept the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions.

2. Financial markets and monetary developments

During 2024 Q2, the daily average interest rate on interbank transactions[33] The average interest rate on transactions in deposits on the interbank money market, weighted by the volume of transactions. reduced visibly its fluctuations around the deposit facility rate, while longer‑term rates on the interbank money market remained quasi-constant April through May, before declining mildly in June. The EUR/RON exchange rate reverted in mid-April and stuck for the following two months to the higher readings it had temporarily climbed to at the beginning of 2024. The annual growth rate of liquidity across the economy resumed its upward path during the first two months of Q2 overall, although at a slow pace, while that of credit to the private sector picked up, after the previous three months’ decrease.

2.1. Interest rates

In Q2, the daily average interest rate on interbank transactions moderated visibly its fluctuations around the lower bound of the interest rate corridor, rising during the period overall by 0.10 percentage points versus the previous three months, to 5.99 percent[34]. Average weighted by the volume of transactions.

Behind these developments further stood the behaviour of shorter-term rates, of up to one week, amid the persistence of a particularly wide liquidity surplus on the money market, which the central bank continued to mop up via the deposit facility[35]. The average daily stock of these deposits shrank slightly to lei 48.7 billion April through June 2024 overall, from lei 50.9 billion in Q1.

The 3M-12M ROBOR rates held quasi-steady in the first two months of Q2, before witnessing minor declines in June, probably amid the consolidation of credit institutions’ expectations on the NBR lowering key rates in the near run, given inter alia the accelerated and above-expectations drop in the annual inflation rate during April and May. Thus, their quarterly averages moderated their decrease against the previous period, reaching 6.04 percent for the 3M rate (down 0.06 percentage points), 6.06 percent for the 6M maturity (down 0.08 percentage points) and 6.07 percent for the 12M rate (down 0.08 percentage points) (Chart 3.2).

On the government securities market, the developments reflected however markedly, in particular for medium and long maturities, the effects exerted by the higher volatility of international financial market sentiment in Q2, amid the successive revisions of investor expectations on the outlook for the Fed’s monetary policy stance[36]. April saw the emergence of expectations that the Fed would keep the interest rate unchanged for longer, mainly as a result of the faster-than-anticipated dynamics of inflation in the US. In the first part of May, investor expectations for the Fed to launch the interest rate lowering cycle in September 2024 increased, however, progressively; afterwards, the start of this cycle in December was temporarily seen as more likely. Behind the revisions stood the mixed signals conveyed successively by the labour market data, as well as by the Fed’s monetary policy communication, including the FOMC members’ concerns about the persistence of still elevated inflation, as shown in the minutes of the 30 April-1 May meeting (released on 22 May). Against this background, long-term US Treasury yields accelerated their increase in April, before embarking on a downward, albeit strongly fluctuating course. In the closing month of the quarter, market developments were influenced by the temporary relative worsening of the risk perception towards the region.

At that juncture, medium- and long-term reference rates on the secondary market[37] Bid-ask averages. (5-10 years) steepened/resumed their growth in April and, after a moderate downward adjustment in the first part of May, climbed and then stuck to identical or higher values compared with those reached in the opening month of the quarter. The 3-year rate witnessed a similar behaviour in the first half of the quarter, but then remained relatively stable, whereas rates at the shorter end of the maturity spectrum (6 months and 12 months respectively) heldquasi-steady during Q2 (Chart 3.3). Therefore, the monthly averages of the rates added up to 0.27 percentage points for the 5- and 10-year maturities (to 6.48 percent and 6.81 percent respectively) and rose slightly for the 3-year maturity (+0.09 percentage points, to 6.20 percent), while remaining virtually unchanged (at 5.95 percent) for the shorter maturities, of 6-12 months. Against this backdrop, the yield curve saw its positive slope steepen further.

The average accepted rates on the primary market[38] During Q2, the “Tezaur” programme saw the monthly issuance of government securities with 1- and 3-year maturities, at rates of (i) 6.10 percent and 6.85 percent respectively in April, (ii) 6.00 percent and 6.85 percent respectively in May, and (iii) 6.00 percent and 6.85 percent respectively in June. Moreover, in April, the MF issued government securities for households under the “Fidelis” programme, both in domestic currency, with 1- and 3-year maturities, at rates of 6.00 percent and 6.85 percent respectively, worth around lei 1.3 billion, and in euro, with 1- and 5-year maturities, at rates of 4.00 percent and 5.00 percent respectively, totalling EUR 383 million. In addition, in May the MF issued on the external market EUR-denominated Eurobonds with 8- and 13-year maturities, at rates of 5.33 percent and 5.69 percent respectively, totalling EUR 3.2 billion. recorded relatively similar developments. Specifically, they added up to 0.25 percentage points in June against the March readings for the 5-, 7- and 10-year maturities (to 6.62 percent, 6.69 percent and 6.82 percent respectively), while staying almost still for the 12-month securities (at 6.02 percent). During Q2 overall, the value of securities issued rose by lei 4 billion against the previous three months, to lei 32.5 billion[39], The value of net issues shrank, however, markedly in Q2 versus the previous three months (by around lei 17 billion, to lei 9.1 billion), given the large volume – representing a historical high – of securities maturing in this period (lei 23.4 billion). yet amid the sizeable increase in the volume and share of short-term securities, to the detriment of those of 5 to 10‑year securities[40]. During Q2 overall, the ratio of the amounts of bids submitted by primary dealers to the announced volume at MF auctions edged down to 2.15 (from 2.28 in the previous quarter), while the ratio of the volume of issues to the announced volume by the MF climbed slightly to 1.67 (from 1.50 in Q1).

The average interest rate on new loans to non-bank clients resumed its decline in April-May, at a swift pace (-0.60 percentage points, to an average of 8.20 percent), while the average remuneration of new time deposits decreased further, although more slowly than in the previous two quarters (-0.12 percentage points, to 5.36 percent) (Chart 3.4).

The downward paths were broad-based from a sectoral perspective. Specifically, the average lending rate on new business to households fell considerably after the Q1 standstill (down 0.69 percentage points, to 8.20 percent), primarily amid the steeper decline of the average interest rate on new consumer loans (-1.62 percentage points, to 9.53 percent), attributable inter alia to keener competition in this market segment[41] In the May 2024 Bank Lending Survey conducted by the NBR, credit institutions pointed to stronger competition in the banking sector as the main driver behind the easing of credit standards for consumer loans in 2024 Q1, anticipated to extend into Q2. (Chart 3.5). A more modest influence also came from the slightly faster decrease in the average interest rate on new housing loans, which shed 0.23 percentage points, to an average of 6.59 percent.

In turn, the average lending rate on new business to non-financial corporations witnessed a more pronounced drop April through May than in the previous three months, i.e. down 0.40 percentage points, to 8.21 percent (Chart 3.6). This reflected developments in the average interest rates on both major types of loans: low-value (below EUR 1 million equivalent), which shed 0.24 percentage points (to 8.66 percent), and high-value (above EUR 1 million equivalent), down 0.71 percentage points, to 7.37 percent.

Looking at new time deposits, the average remuneration moderated its decline for both households (-0.19 percentage points against Q1, to 5.40 percent) and non‑financial corporations (-0.09 percentage points versus Q1, to 5.34 percent).

2.2. Exchange rate and capital flows

The EUR/RON exchange rate reverted in mid-April and stuck for the following two months to the higher readings it had temporarily climbed to at the beginning of 2024 (Chart 3.7).

The EUR/RON recorded an increase in mid-April, returning to the higher values prevailing in the first part of 2024 Q1, while pressures on the exchange rate remained relatively high until the end of the month. This owed to the deterioration of the global risk appetite, under the impact of the recalibration by investors of the anticipated path of the Fed’s key rate[42], Given the above-expectations performance of inflation and of labour market parameters in the US during previous months, as well as following the Fed Chair’s statements that it would take longer to gain greater confidence that inflation was on a steady path back to the central bank’s target. but also to stronger tensions in the Middle East. The upward shift was, nevertheless, much more modest than those seen in the exchange rates of the forint and the zloty, and the EUR/RON remained relatively stable in the second part of the period, inter alia amid the still high relative attractiveness of investments in domestic currency (Table 3.1).

Table 3.1. Key financial account items

The EUR/RON exchange rate stuck in May to the new readings, reflecting the relatively high volatility on the international financial market, but also the uncertainties associated with the budget consolidation process. The domestic currency witnessed only a small episode of appreciation in mid-May, following the temporary improvement in the global risk appetite amid investors reconsidering the outlook for the Fed’s interest rate[43]. Investor expectations for the Fed to launch the interest rate lowering cycle in September increased progressively in the first part of the month; afterwards, the start of this cycle in December was seen as more likely.

The EUR/RON tended to remain at the higher levels or even go up mildly in the closing month of the quarter, reflecting inter alia the temporary deterioration of the risk perception towards the region in view of political events in Europe, as well as amid expectations on the prospects for the NBR’s key rate. The uncertainties surrounding the political stage in Europe, coupled with the wider spread between short-term interest rates in the US and the euro area, also entailed a sudden reversal in the path of the EUR/USD exchange rate, which thus dropped relatively abruptly in the first part of June, largely correcting the increase seen since mid-April. Against this background, the exchange rates of the main currencies in the region versus the euro re‑embarked on a markedly upward course, returning to the vicinity of the higher values prevailing in the first four months of the year (Chart 3.8).

In relation to the US dollar, the leu lost some ground towards mid-April, which it then recovered by mid‑May, before weakening again in June, inter alia amid the former’s appreciation on international financial markets.

The interbank forex market turnover stayed in Q2 at a similar level to that recorded in the previous three months, while the negative balance of transactions contracted, on account of residents’ operations.

During Q2 overall, the leu weakened versus the euro by 0.1 percent in nominal terms[44], Based on the June and March 2024 averages of the EUR/RON exchange rate.[45] During the same period, the Czech koruna and the forint strengthened 2.1 percent and 0.1 percent respectively against the euro, whereas the zloty depreciated 0.3 percent. and slowed its pace of appreciation in real terms to 0.1 percent. In relation to the US dollar, the domestic currency depreciated 1.1 percent in nominal terms and 0.8 percent in real terms. Looking at the annual change in the quarterly averages of the exchange rate, the leu moderated its depreciation against the euro in Q2, but weakened again versus the US dollar.

2.3. Money and credit

Money

The annual dynamics of broad money (M3) resumed their advance, on average, inApril-May, albeit at a slow pace, going up to 10.9 percent[46] In real terms, the annual dynamics of M3 saw a sharper rise, to 5.1 percent from 3.3 percent in 2024 Q1. (from 10.6 percent in the previous two quarters), correlated with the characteristics of budget execution (Table 3.2).

Table 3.2. Annual growth rates of M3 and its components

The stronger momentum of monetary expansion was driven by the dynamics of narrow money (M1), which continued to increase relatively fast, mainly following the lower contraction in foreign currency-denominated overnight deposits – primarily in the case of non-financial corporations –, as well as due to the further pick-up in the growth of households’ leu-denominated overnight deposits. A modest contribution also came from currency in circulation, whose annual change resumed its uptrend, reaching a nine-quarter high (Chart 3.9).

In parallel, time deposits with a maturity of up to two years posted a slower loss of momentum compared to the previous quarters, given the relatively similar developments in the leu- and foreign currency-denominated components, as well as at sectoral level. Against this background, the share of M1 in M3 further narrowed, albeit at a slacker pace, reaching 59.2 percent in May, from 59.4 percent in March.

The breakdown by holder shows that the slight advance in M3 dynamics was driven by the rate of change of household deposits, which resumed its increase, even amid the significant rise in the purchases of goods[47] The annual dynamics of retail trade turnover (with the exception of trade in motor vehicles and motorcycles) went up to 10.2 percent April through May overall, from 6.7 percent in 2024 Q1. and the sharper hike in annual terms of this sector’s holdings of government securities in April-May, on the back of the robust growth of real disposable income, albeit fluctuating at monthly level, given the earlier payment in April of pensions and some social security benefits for May. By contrast, the annual dynamics of non-financial corporations’ deposits declined from 2024 Q1, amid the drop in receipts from EU funds in annual terms and the marked deceleration in the growth of receipts from public investments[48], According to general government budget execution data. as well as in correlation with the rise in payments for certain budgetary obligations (mainly corporate income tax) and with the slower dynamics of credit to this sector in this period as a whole.

From the perspective of M3 counterparts, expansionary influences throughout the period came from small increases in dynamics posted by credit to the private sector and by net credit to the central government, as well as from a decline in the growth rate of long‑term financial liabilities[49], Capital accounts included. whereas opposite effects were generated by the change in net foreign assets of the banking system, which continued to contract, albeit more slowly than in the previous quarter.

Credit to the private sector

The annual dynamics of credit to the private sector went up to 5.8 percent[50] In real terms, the annual dynamics of credit to the private sector increased to 0.2 percent, from -1.8 percent in 2024 Q1, thus re-entering positive territory for the first time in seven quarters. in April‑May, after decreasing to 5.1 percent in 2024 Q1, given that the domestic currency component continued to grow at a swifter pace, whereas the rate of change of foreign currency credit (expressed in EUR) moderated its fall yet again (Chart 3.10). Against this backdrop, the share of leu-denominated loans in total credit narrowed marginally, to 68.8 percent in May from 68.9 percent in March.

The step-up in the dynamics of credit to the private sector was fully ascribable to household loans, whose pace of increase gained momentum in this period as well, solely on the back of the leu‑denominated component (Chart 3.11). The latter further recorded a swifter growth rate in the first two months of 2024 Q2 overall, mainly prompted by the rate of change of consumer credit, which climbed to a two-digit level – for the first time in 21 quarters[51] –, Assessment based on the quarterly averages of annual growth rates. given that the flows of this type of loans reached a historical peak in April and went down only slightly in May[52]. Assessment based on the amounts adjusted for renegotiated loans. In turn, the relatively more moderate annual dynamics of housing loans stuck to an upward path, under the influence of the significantly higher volume of new loans. By contrast, the annual rate of change of foreign currency-denominated credit to households (expressed in euro) continued to contract at a faster pace compared to the same year‑ago period.

However, the annual growth rate of loans to non-financial corporations further declined, under the impact of a new loss of momentum witnessed by the foreign currency component, which was sharper in the case of medium- and long-term loans. At the same time, the annual rate of change of leu-denominated loans halted its uptrend from the previous three quarters, given that the pick-up in the growth rate of short‑term loans in this period was fully offset by the decline in the stock of medium- and long-term loans, inter alia amid the lower volume of loans granted under government programmes.

4. Inflation outlook

The annual CPI inflation rate is projected to stay on a downward track over almost the entire forecast interval, yet the pace of disinflation will slow visibly in the latter half of the period. Looking at components, the adjusted CORE2 inflation will decline gradually and subsequently more slowly over the medium term, while the remaining basket items will make a more volatile cumulative contribution in the first part of the projection interval, reflecting inter alia a number of base effects. In the short term, disinflation will see a short-lived halt in July 2024, chiefly due to higher motor fuel prices (given the hike in the excise duty). Subsequently, inflation will revert to a downward path, temporarily returning inside the variation band of the target in 2025 Q1, to 2.9 percent, the sizeable drop being explained by favourable base effects associated with the fading impact of the increase in indirect taxes in January 2024. After briefly exceeding the interval in the following quarter (3.7 percent), due also to base effects, inflation will return and remain in the upper half of the variation band of the target until the projection horizon. Against this backdrop, the indicator is anticipated to stand at 4 percent at end-2024, a value revised downwards by 0.9 percentage points, with a notable contribution from recent developments, which were more favourable than previously expected for both the adjusted CORE2 index and energy prices. For the end of next year, the projected figure is 3.4 percent (revised downwards by 0.1 percentage points), before reaching 3.2 percent in June 2026 (the forecast horizon). The assessed balance of risks continues to suggest possible upward deviations of inflation from its path in the baseline scenario, owing to potential adverse supply-side shocks arising from multiple geopolitical tensions. Adding to these is the uncertainty surrounding the future fiscal and income policy stance, as well as the risks posed by rather high labour market tightness.

1. Baseline scenario

1.1. External assumptions

The economic activity of external trading partners, as proxied by the EU effective GDP, fared better in 2024 Q1 than previously foreseen. However, over the short term, economic growth remains contained by the tight financial conditions. Specifically, for 2024 Q2 and Q3, moderate quarterly growth in economic activity is envisaged and a stabilisation trend is expected thereafter. Over the medium term, economic activity is set to gain momentum. In this vein, contributions are anticipated to come from the stronger purchasing power of households, the restoration of firms’ confidence, the recovery of extra-EU demand and the further easing of the ECB’s monetary policy. The projected average annual growth of EU effective GDP was reassessed, from 0.9 percent to 1 percent for this year, while for 2025 it was maintained at 1.7 percent (Table 4.1).

Table 4.1. Expected developments in external variables

Against this background, the effective external output gap was reassessed mildly upwards. It is projected to show a demand deficit until the end of this year, subsequently taking slightly positive values until the forecast horizon.

The projected euro area average annual inflation rate (HICP) was revised upwards compared to the previous Report (+0.2 percentage points in both 2024 and 2025), due mainly to the energy component (higher oil prices) and the recent swifter-than-expected dynamics of services prices. Hence, the euro area average annual inflation rate is anticipated to reach 2.5 percent for this year and 2.2 percent for next year. The swings in the annual inflation rate during the quarters of this year reflect a number of base effects related to the energy component. The slow-paced downward dynamics of the annual headline inflation rate mirror the anticipated performance of the services component. The annual inflation rate is foreseen to reach the ECB’s 2 percent benchmark no earlier than 2025 Q4, a quarter later than envisaged in the previous Report.

Compared to the prior round, the forecast of euro area HICP inflation excluding energy[53] A proxy for imported inflation in the case of Romania. was maintained at 2.8 percent for 2024 and revised slightly upwards, by 0.1 percentage points, to 2.3 percent for 2025. Looking by quarter, it will follow a downward track, at a swifter pace than headline inflation over the short and medium term. The gradual moderation of pay rises in the euro area plays an important part in the evolution of the HICP inflation rate excluding energy amid persistent labour market tightness. In the medium term, profit margins are foreseen to act as a buffer for the pass‑through of labour costs to final prices of goods and services. At the projection horizon, i.e. 2026 Q2, the HICP inflation rate excluding energy is expected to run slightly above headline inflation, at 2.1 percent versus 1.9 percent.

The nominal 3M EURIBOR rate hit a local high of 4 percent in 2023 Q4, while in 2024 Q1 and Q2 it witnessed a number of slight reductions. Its gradually downward path is anticipated to continue throughout the projection interval, albeit at a less sustained pace than in the preceding three months. The real 3M EURIBOR rate is estimated to remain in positive territory, peaking in 2024 Q2 (amid softer inflation expectations in the euro area), before falling gradually over the forecast interval. Hence, it will further exert a restrictive impact on the euro area economy, yet somewhat stronger than that assessed in the previous projection round, amid expectations of a slower decline in the nominal rate.

The path of the EUR/USD exchange rate continues to be surrounded by broad uncertainty. Over the short term, it will remain relatively stable and subsequently the euro is projected to strengthen progressively during the forecast interval. This path takes shape against the background of expectations over the monetary policy pursued by the ECB and the Fed, respectively.

The scenario for the Brent oil price is based on futures prices and foresees a downswing, given the prospective slowdown in global economic activity. Specifically, at the forecast horizon, the Brent oil price is projected at around USD 77/barrel (Chart 4.1). On the demand side, concerns about weakening global economic conditions prevail over the short and medium term, weighing on oil demand. On the supply side, there are clear signs of lower oil stocks, owing to both weaker production from the US and the OPEC+ members’ agreement to extend their oil output cuts until the end of 2024 Q3. Furthermore, geopolitical tensions in the Middle East keep fuelling fears about potential disruptions to oil supplies from the region. Consequently, despite the descending path of the oil price, as shown by futures prices, it is worth highlighting the broad uncertainty about its developments, with more likely upward deviations in the period ahead.

1.2. Inflation outlook

The annual CPI inflation rate remained on a downward path in 2024 Q2, falling to 4.94 percent in June, from 6.61 percent in March. This decline owed largely to core inflation, but also to favourable developments in natural gas and electricity prices as well as in volatile food prices (VFE), with exogenous components accounting for about half of the progress seen in CPI dynamics in 2024 Q2.

According to the baseline scenario, the overall downward trend in the annual CPI inflation rate will persist almost throughout the projection interval, but the pace of disinflation is forecasted to slow down markedly in the latter half of the period (Chart 4.2). The breakdown shows that core inflation is projected to decline gradually and, subsequently, at a slower pace over the medium term, while exogenous components are seen making a more volatile cumulative contribution during the first part of the forecast interval, reflecting inter alia a number of base effects.

In the short run, disinflation is expected to come to a halt temporarily in July 2024, mainly on account of the anticipated hikes in motor fuel and natural gas prices, caused by the rises in the excise duty and distribution tariffs respectively. After resuming its decline in August, the annual CPI inflation rate is projected to reach 4 percent at end-2024. It will then fluctuate significantly in the first part of 2025, under the impact of substantial base effects. Specifically, headline inflation will reflect favourable influences at the beginning of 2025, due to the hike in some indirect taxes in January 2024 dropping out of the calculation, and is expected to reach a short-lived low of 2.9 percent in March 2025. In 2025 Q2, opposite effects will become manifest, associated with the 2024 Q2 corrections in natural gas and VFE prices, driving inflation yet again above the variation band of the target, to 3.7 percent in June 2025. Subsequently, once the transitory influences linked to the previous year’s base effects have stabilised, the annual inflation rate will return into the upper half of the variation band. Specifically, the indicator is forecasted to reach 3.4 percent at end-2025 and 3.2 percent in June 2026 (Table 4.2). Against this background, aside from the extremely favourable developments foreseen for 2025 Q1, the annual inflation rate will stabilise inside the variation band of the target starting 2025 Q3.

Table 4.2. CPI and adjusted CORE2 inflation in the baseline scenario

Compared to the trajectory released in the May 2024 Inflation Report, the annual CPI inflation rate was revised downwards almost throughout the projection interval, more visibly in the first part of it. The revision was prompted mainly by the recent actual developments, which proved more favourable than previously expected. The new forecast stands 0.9 percentage points lower at end-2024, owing largely to utility prices, core inflation, and to a lesser extent, VFE price dynamics. The projected annual CPI inflation rate was revised downwards by 0.1 percentage points for end-2025, largely on the back of core inflation.

In turn, the annual adjusted CORE2 inflation rate remained on a downward path in 2024 Q2, falling from 7.1 percent in March to 5.7 percent in June. The indicator will continue to decline, albeit at a significantly slower pace in the latter half of the forecast interval. Specifically, the annual core inflation rate is projected at 4.6 percent at end-2024, 3.5 percent in December 2025 and 3.4 percent in June 2026 (Chart 4.2).

The breakdown by sub-component shows that the anticipated trajectory of core inflation reflects primarily the gradual deceleration in the annual dynamics of prices for non-food items and services, from the still elevated levels recorded in June, i.e. 8.6 percent and 8.0 percent respectively. Recent data indicated a drop in the monthly rates of these sub-components, corroborated by the trend in industrial producer prices for non-food items excluding energy. In addition, the annual growth rate of unit labour costs is projected to decline, while further posting robust values. At the same time, the food sub-component will continue to reflect favourable influences from international agri-food commodity prices, which are passed through along the production chain into producer prices of the domestic food industry. Specifically, the annual dynamics of the food sub-component of core inflation, which stood at 2.1 percent in June, are foreseen to remain significantly lower than those of the other sub-components of the core index.

Looking at the underlying inflation factors, the curbing of core inflation over the forecast interval is due to a significant extent to the ongoing downward correction of inflation expectations, i.e. the component making the strongest contribution to core inflation developments. Additional influences will come from the growth rate of import prices, which is expected to decline in the first part of 2024 and stabilise thereafter, in line with the projected annual dynamics of euro area HICP inflation excluding energy[54]. According to the June 2024 Eurosystem staff macroeconomic projections for the euro area, the average annual growth rate of the indicator will fall from 2.8 percent in 2024 to 2.3 percent in 2025 and 2.1 percent in 2026. The slowdown in disinflation, more visible in the latter half of the forecast interval, is attributable to the output gap remaining in positive territory, as well as to inflation expectations, albeit on the wane, staying at levels above the variation band of the target until the forecast horizon.

Compared to the previous round, the annual core inflation rate was revised downwards throughout the projection interval, by 0.7 percentage points for end-2024 and 0.2 percentage points for end-2025. The revision was underpinned by the more favourable recent signals in the non-food and services segments, along with the downward correction of inflation expectations and, to a lesser extent, of the output gap.

The cumulative contribution of the exogenous components of the consumer basket to the annual CPI inflation rate is projected at 1.1 percentage points at end-2024 (a significant downward revision of 0.5 percentage points compared to the May 2024 Inflation Report), 1.2 percentage points in December 2025 (unchanged), and 1.1 percentage points in June 2026 (Chart 4.3). The downward revision for December 2024 is almost entirely due to more favourable developments in the dynamics of utility prices (natural gas, electricity), as well as of fuel and volatile food prices, which were partly offset by upward corrections in administered prices.

The annual growth rate of fuel prices is anticipated to run above the central target until end-2025 Q2 (Chart 4.4, Table 4.3). The main driver of the developments forecasted for the first half of the projection interval will be the path of oil prices[55]. For further details, see Section 1.1. External assumptions. Subsequently, annual growth rates are expected to moderate around the mid-point of the target as of 2025 Q3, due to the fading-out of the statistical effect associated with the July 2024 excise duty hike[56], With an estimated impact of 3.1 percentage points on the monthly inflation rate for fuels and 0.29 percentage points on the CPI inflation rate. along with an anticipated stabilisation in oil futures prices. The variable’s path was revised significantly downwards this year compared to the prior Inflation Report, as a result of more favourable developments in the oil price.

Table 4.3. Inflation of CPI exogenous components

Against the backdrop of the changes in the parameters of the price capping scheme for household consumers at the beginning of 2024 Q2[57], As of April 2024, a number of legislative changes have been implemented with the aim of lowering the sales price on which producers are overtaxed. These measures have enabled the reduction in electricity and natural gas prices for household consumers. the annual rate of change of electricity and natural gas prices[58] According to NIS Press Release No. 37/14 February 2023, electricity and natural gas were re-included in the group of administered price items of the CPI basket, following the changes made to the energy price capping and compensation schemes as of 1 January 2023. is forecasted to remain in negative territory until the end of March 2025, when the measure expires (Chart 4.4, Table 4.3). The group is afterwards foreseen to witness benign developments in terms of its contribution to inflation, under the assumption of a normal functioning of the relevant markets. Compared to the previous Report, the path of the electricity and natural gas price dynamics was revised significantly downwards, more visibly until March 2025, owing mainly to the changes made to the price capping scheme.

The exogenous scenario for administered prices, other than electricity and natural gas[59], The main categories of items included in this group are heating, water, sewerage, sanitation services and medicines. which is built chiefly on historical changes in the group’s sub‑components, foresees that the annual dynamics will decelerate over the next five quarters to values close to the mid-point of the target, before stepping up slightly towards end-2025, and stabilising afterwards close to the upper bound of the variation band of the target (Chart 4.5, Table 4.3). Compared to the previous Inflation Report, values were revised more notably upwards only for the first part of the forecast interval, mainly due to larger-than-anticipated price increases in April, May, and June, particularly in the water, sewerage, and sanitation services segment. Over the remainder of the projection interval, the annual growth rate of administered prices is projected close to that shown in the prior Report, based on the historical pattern of changes to the prices of the main items in this group.

The annual pace of increase of volatile food prices (VFE) is expected to fluctuate inside the variation band of the target during this year (Chart 4.6, Table 4.3). This favourable development mirrors relatively bountiful crops in the first part of the year. Nevertheless, it should be noted that the forecast for this component depends almost entirely on weather conditions, which have recently become highly unpredictable. Over the remainder of the projection interval, the annual growth rate of this group is estimated to pick up gradually, reflecting the assumption of normal agricultural years[60]. Relative to their multiannual averages.

The path of the annual growth rate of tobacco product and alcoholic beverage prices is shaped primarily by higher excise duties provided for in the legislation, but also by the behaviour of companies in this field as regards the final price adjustment. The annual dynamics of this group are anticipated to decelerate until 2025 Q2, before stabilising inside the variation band of the target over the remainder of the forecast horizon (Table 4.3). For this year, the annual pace of increase of this group is influenced by a recent unexpected price hike in alcoholic beverages. Under the circumstances, the forecast for December 2024 was revised slightly upwards, while for the remainder of the interval the path of tobacco product and alcoholic beverage price dynamics is similar to those projected in the previous Report.

1.3. Demand pressures in the current period and over the projection interval

The output gap

According to the NIS Press Release of 8 July 2024, in 2024 Q1 real GDP dynamics in quarterly terms returned to positive territory (+0.7 percent), yet they were lower than expected in the previous Report. On the demand side, however, negative contributions came from both domestic demand (particularly the unanticipated GFCF contraction, but also the near-stagnation of household consumption) and net exports. In this context, the contribution from residual components (statistical discrepancy and the change in inventories) was significantly positive (+2.4 percentage points), and given its large size, it suggests potential subsequent revisions of the data series.

For 2024 Q2 and Q3, short-term forecasts point to relatively robust quarterly growth rates of real GDP. These reflect the generally favourable signals coming from high‑frequency indicators. Specifically, trade and services are expected to have a favourable performance, amid the strengthening of households’ purchasing power (as faster disinflation is foreseen to overlap public sector pay rises as well as increases in the minimum wage and in pensions). These expectations are supported by consumer confidence going up visibly, even if to a lesser degree in the services sector (the DG ECFIN survey), and, conversely, moderated by mixed developments in the turnover volumes for these two sectors in the first two months of Q2. At the same time, although the statistical data indicate a significant rebound in construction works after the difficult-to-explain decline in Q1, industrial indicators were strongly affected in May, which keeps the outlook for this sector’s future dynamics relatively modest. This assessment is corroborated by the weakening of confidence in this sector, according to the DG ECFIN survey and the Purchasing Managers’ Index (PMI) survey in manufacturing. However, in the economy as a whole, the ESI (Economic Sentiment Indicator) peaking since the onset of the pandemic and the generic level of uncertainty, measured by the divergence of analysts’ forecasts, standing slightly below the historical average, are favourable signals for the short-term outlook. Against this background, international trade flows are seen to gradually pick up, reflecting, on the one hand, the further rebound in external and domestic demand, and, on the other hand, a relatively pessimistic investor sentiment in the euro area (suggested by the euro area ESI stagnating below the long-term average and the deterioration of Sentix survey responses).

Given the underperformance of GDP in Q1, the outlook for 2024 points to an average annual growth close to that recorded last year[61]. In 2023, the annual real GDP growth stood at 2.1 percent. The contribution of the change in inventories, a component with limited economic content, was negative and it was large, suggesting uncertainties regarding the final composition of GDP growth (which results after the NIS makes all revisions of statistical data). The data on GDP dynamics in 2023 are provisional, whereas the semi-final and final ones are expected to be released at end-2024 and end-2025, respectively. The projection mirrors, inter alia, the high level of uncertainty stemming from the numerous geopolitical tensions, the sluggish industrial activity (both domestically and in the largest European economies, with a direct impact on Romanian exports), and the restrictiveness of real broad monetary conditions. For 2025, similarly to the previous Report, economic activity is expected to gain momentum, yet the forecast relies heavily upon the fiscal and income policy stance (which is anticipated, strictly based on the information available at the time this analysis was completed, to have a stimulative effect on economic activity), to which adds the recovery of external demand. By contrast, real broad monetary conditions are assessed to maintain their restrictive nature throughout the entire projection interval. A favourable contribution to economic growth is envisaged to stem from turning EU funds from multiple sources to good account, although this process has already recorded some delays in the actual use of these amounts within investment projects[62]. The Multiannual Financial Framework 2021-2027, the Next Generation EU programme (2021-2026).

The real GDP path is projected to be entirely shaped by domestic demand. Throughout the current year, final consumption is estimated to become again the main driver of economic growth (due to its high share in GDP and the strong advance of the component), to this adding the contribution of the GFCF increase, which is likely to slow down compared to last year, yet to remain robust (under the assumption of EU funds absorption, but also foreign direct investment inflows). After the close‑to‑nil value in 2023, as of this year the contribution of net exports is projected to turn negative again, amid the dynamics of imports of goods and services expected to rebound faster than those of exports.

Potential GDP dynamics are anticipated to post robust average annual values over the projection interval, slightly gaining momentum in the current year. Compared to the previous Report, potential GDP growth was, however, moderately revised downwards, primarily reflecting the assumption of a lower contribution from investments financed through the Next Generation EU programme.

Capital stock remains the key driver of potential GDP growth, reflecting investments’ overall resilient path. However, their favourable dynamics are expected to record some slowdowns, amid the fading-out of the stimulative effects of real bank interest rates (which were assessed to have turned positive for new loans already since the end of last year) and the impact of some corporate tax measures adopted by the authorities. Thus, the most important funding sources for GFCF will further particularly consist of foreign direct investment and EU funds; the latter have recently gained pace, in particular those under the Multiannual Financial Framework 2021‑2027[63]. In this case, the volume of inflows during 2023 was lower than in 2022, but this trajectory is anticipated to turn upwards again, given the pattern of previous multiannual financial frameworks. By contrast, funds under the 2014-2020 framework were almost used up[64]. Within this framework, expenses were eligible until end-2023, yet invoices can also be settled during 2024. Additionally, the implementation of projects funded through the Next Generation EU programme remains essential. The performance of investments, including in new technology and energy efficiency[65], Romania climbed three places to 36 in the global ranking based on the EY Renewable Energy Country Attractiveness Index (RECAI 63), due to funding programmes and legislation on offshore wind energy, with further growth prospects. is reflected in a significant contribution of total factor productivity (TFP trend) to potential GDP growth. The contribution of labour is foreseen to remain slightly positive, but significantly lower than those of the other two factors, given the relatively slower growth in the number of employees economy-wide and, over the medium and long term, the persistently unfavourable demographic developments in Romania (in particular, the decline in the working-age population aged 15 to 74 – for an analysis on the impact of labour shortage, see the Box), as well as social ones, e.g. youth employment rate[66]. The share of young people aged 16-29 neither in employment, nor in education and training (NEET rate) posted in 2023 the highest values across the EU, significantly above the EU average (19.3 percent versus 11.2 percent). The adverse effects of uncertainty associated with global geopolitical tensions remain relevant to the potential GDP path.

The positive output gap was stuck in 2024 Q1 to the downward path seen throughout the previous year, before reaching in the next two quarters values similar to those estimated in the prior Report. The indicator’s short-term dynamics are related to the anticipated relatively robust quarterly growth rates of economic activity, due inter alia to private consumption returning to strong positive dynamics. In a manner similar to the previous assessment, over the medium term the output gap will closely reflect the fiscal policy stance and the projected developments in the budget deficit, remaining in positive territory throughout the entire forecast interval (Chart 4.7)[71]. From the perspective of aggregate demand components, the output gap path is shaped by those of domestic demand (with household individual consumption and GFCF having high contributions), whereas the aggregate gap of net exports is foreseen to be negative (mainly due to that of imports of goods and services).

From the perspective of output gap fundamentals, the fiscal impulse is assessed to exert approximately neutral effects this year, which will become stimulative in 2025, similarly to the forecast in the previous Report, with an impact on the positive output gap. Moreover, the negative external output gap is expected, the same as in the prior projection, to turn positive again at the beginning of 2025. By contrast, the monetary policy stance remains restrictive over the entire forecast interval.

Aggregate demand components

In 2024, final consumption is expected to become again the key driver of economic growth. This component is anticipated to rise steadily over the remainder of the forecast horizon. Its developments benefit from the swift rise in real disposable income, supported by both wage increases (reflecting also the measures taken by the authorities to boost income earnings[72]) The measures that entered into force as of 1 January 2024 refer primarily to: (i) the increase in the state allowance for children, in the pension point and in the minimum pension; (ii) the hike in public sector wages, followed by an additional indexation in June. Moreover, starting 1 July 2024, the minimum wage was raised by 12.1 percent (from lei 3,300 to lei 3,700). New rises in disposable income are anticipated due to the pension recalculation as of 1 September 2024. In addition to these measures, social cards of lei 250 will be granted every two months. and the inflation decline, thus paving the way for a stronger household purchasing power. However, the uncertainties further arising from the war in Ukraine and the Middle East conflict remain relevant in the medium term, alongside those generated by domestic factors, mainly related to the design of fiscal consolidation measures to be implemented by the authorities. This context could extend a certain recent trend of moderating consumption, especially with regard to vulnerable consumers[73]. For 2024, the EY Consumer Index (December 2023) shows a certain moderation trend in consumer behaviour as households are adapting to the continuous increase in the cost of living and to higher taxes and charges. At the same time, according to the PwC Voice of the Consumer Survey Romania 2024, inflation continues to be a risk for the Romanian economy, mentioned relatively frequently, i.e. by 74 percent of the respondents.

Over the forecast interval, gross fixed capital formation is expected to see robust average annual growth rates, higher than those of final consumption. However, compared to the exceptional performance in 2023, the component’s dynamics will probably decelerate. The prospects of a further strong performance of GFCF are strictly conditional on the pick-up in both domestic and external economic activity, on investor confidence[74], An analysis conducted in April 2024 by the Sierra Quadrant consulting firm reveals that many companies have resorted to preventive restructuring in order to reduce their exposure in the event of a negative financial impact, given the multiple challenges posed by tax changes, the labour crisis and technological developments. as well as on the authorities’ accomplishments regarding the further EU funds absorption from multiple sources, with stimulative effects on the projects carried out in the private sector. The Next Generation EU programme plays a key role in investments financed via EU funds, yet the former’s progress is expected, at least based on the developments recorded so far, to be slow when it comes to the actual implementation of the allocated and transferred amounts. The GFCF dynamics could be affected by the adoption of fiscal reforms that have increased corporate taxation, with repercussions on investment resources. Furthermore, the fiscal reforms that are not predictable and reasonable in scope could cause significant changes in the companies’ investment plans.

During 2024, both exports and imports are envisaged to return to positive annual dynamics. Over the medium term, the developments in exports of goods and services will remain affected by the uncertainty associated with the unfolding of armed conflicts, and by the trade flows’ still pending recovery or, as the case may be, coming under the impact of new disruptions. In the event of escalating geopolitical tensions, international trade flows could be hampered by a potential resurgence of global supply chain bottlenecks. The recent, unanticipated contraction in industrial production in May versus April is seen to have both a short-term and a potential medium-term influence on the dynamics of Romanian exports. As for monetary conditions, the real effective exchange rate (calculated by deflating by the consumer price indices in Romania and its trading partners) is projected to remain overvalued until the forecast horizon, and thus to further exert restrictive effects on the price competitiveness of Romanian products, yet on a gradual decline as of the final part of this year. After the fall in 2023, imports of goods and services are foreseen to increase at a faster pace than exports, reflecting the developments in domestic demand components, in particular the rise in consumption. In light of this, net exports are anticipated to make again a negative contribution to economic growth as of this year.

The current account deficit is expected to record a number of corrections over the medium term as well, but these will probably be smaller than that in 2023, which was of about 2.2 percentage points against 2022. In this regard, the measures already enacted, e.g. the pension recalculation and the public sector pay rises, are assessed to also reflect in the external imbalance, which is likely to remain at high levels in 2025 as well. Such developments mirror, inter alia, the limited capacity of domestic production to accommodate excess demand. After having slightly expanded in 2023, the current account deficit coverage by stable, non-debt-creating capital flows is assessed to abate starting with 2024. As for capital transfers, the decrease in EU funds reimbursements under the 2014-2020 MFF will probably be only partially counterbalanced by the outlook for improved inflows under the 2021-2027 MFF. Foreign direct investment, albeit losing momentum since its marked increase in 2021‑2022, is expected to remain at robust levels, standing in absolute terms above those in the pre-pandemic period.

Broad monetary conditions

According to the transmission mechanism, broad monetary conditions capture the cumulative impact exerted on future developments in aggregate demand by the real interest rates applied by credit institutions on leu- and foreign currency-denominated loans and deposits of non-bank clients, and by the real effective exchange rate of the leu. The exchange rate exerts its influence via the net export channel, as well as via the effects on the wealth and balance sheets of economic agents.

The baseline scenario of the projection envisages that real broad monetary conditions will continue to be restrictive over the entire forecast interval. This will occur amid a further pass-through into the economy of the monetary policy decisions made by the NBR Board, which aim to ensure and safeguard price stability over the medium term, in a manner conducive to achieving sustainable economic growth.

Looking by component, real interest rates on both new loans and new time deposits in lei have visibly reduced their stimulative influence over the past quarters, with their gaps being anticipated to gradually close, reaching almost neutral values towards the end of the projection interval. This is projected to take place as monetary policy decisions pass through to nominal interest rates, along with a continuously downward trend of inflation expectations. The real effective exchange rate (Chart 4.8) will further generate restrictive effects on the price competitiveness of Romanian products via the net export channel (nevertheless, this impact is relatively weaker compared to the previous Report). The contribution of the real effective exchange rate is estimated in the context of the previous appreciation of the domestic currency in real terms, associated with the prevailing effect of the higher domestic inflation rate compared to those of Romania’s trading partners.

The wealth and balance sheet effect is assessed to further post restrictive values, albeit slightly diminishing over the projection interval. The breakdown shows that its dynamics mainly reflect the downward path of the real foreign interest rate (3M EURIBOR), after the latter is estimated to have reached a peak in 2024 Q2, given the gradual decline in the nominal rate, the influence of which is partly offset by the falling inflation expectations in the euro area. At the same time, the sovereign risk premium for Romania is projected to have a restrictive impact, mirroring the imbalances associated with the twin deficits in the economy and the effects of the war in Ukraine on investor perception. The dynamics of the leu’s real effective exchange rate gap via the wealth and balance sheet effect are seen to exert a quasi‑neutral impact.

2. Risks associated with the projection

The balance of risks to the future evolution of the annual inflation rate (Chart 4.9) is assessed to remain tilted to the upside. Uncertainties continue to surround the economic impact of multiple and persistent geopolitical conflicts, as well as the future configuration of the fiscal consolidation package. Similarly to the previous Reports, demand-side factors could have a rather disinflationary impact.

The baseline scenario is built on the principle that fiscal measures are included in it only after their enactment into law or at least once they are due for enactment. Thus, a considerable source of risks relates to the configuration of the future fiscal consolidation package, which is necessary amid the build-up of a large budgetary imbalance overlapping with the excessive deficit procedure already pending against Romania. At this point in time, key information is missing on the envisaged individual corrective measures as well as on the time of their entry into force. Based on the features of the package, the net impact on the inflation rate could be both inflationary (for at least 12 months, in the event it includes the increase in indirect tax rates and depending, inter alia, on the magnitude of the adjustments that may be considered) and disinflationary (prevailing in the longer term, regardless of the measures to be adopted, as a result of the fiscal correction and, implicitly, of its impact on aggregate demand). The changes in the fiscal legislation or, as the case may be, the containment of government consumption are expected to be correlated with the medium-term fiscal structural plan imposed by the European Commission. The information publicly available shows that fiscal adjustment might take longer, up to seven years, implying a proportional decrease in the average annual fiscal consolidation effort.

Romania has already recorded large deviations from the excessive deficit correction path and the busy 2024 electoral calendar does not rule out the risk of an additional fiscal slippage either. Further delays in adjusting this imbalance could also reflect in the already persistent external deficit and trigger downgrades by credit rating agencies. This would have an adverse impact on the sovereign risk premium and, implicitly, on the exchange rate and the annual inflation rate. At the same time, however, uncertainties also stem from the adjustment behaviour of economic agents to deficit correction measures. A possible hike in income taxation could lead to higher wage increases than in the baseline scenario in order to safeguard net income, which in turn could translate into higher final prices of goods and services. In fact, given the relatively high labour market tightness, persistent inflationary pressures could stem from minimum wage hikes, fast pay rises in the public sector, but also from the strong competitive nature of labour markets. Moreover, the balance of risks is assessed to remain tilted to the upside even over the medium and long term, in the context of possible heightening structural tensions in the labour market (the skills mismatch in certain sectors, stronger waves of migration or the steeper demographic decline).

By contrast, in the particular case of the public sector, the upside risks to wage dynamics are assessed to be on the decrease, amid the successive increases already granted or to be granted during the current year. Given the stringent need to adjust the budget deficit and the size of public debt, the application of the fiscal responsibility law[75] Law No. 69/2010, republished, stipulates that where public debt exceeds 50 percent of GDP, the government must present a programme for cutting the debt ratio that would include, without being limited to, measures designed to freeze expenditure on public sector wages. could have an impact on the public sector wage bill as well.

At the same time, the international environment continues to be marred by multiple, persistent geopolitical tensions, although the direct economic effects are still relatively mitigated. Price spurts could arise in the event of long-lasting reconfigurations of traditional commercial shipping routes, which would directly affect the price of containerised transport and possibly its insurance prices too. At the same time, the persistent or even deeper fragmentation of international trade could trigger renewed disruptions in global value chains and, in some cases, indefinitely prolong them. Against this background, burdensome logistics could lead to additional costs borne by companies, likely to be passed through into the final prices of goods and services.

Energy prices, especially oil prices, could be affected by new adverse effects in the context of mounting geopolitical tensions. The energy infrastructure could also be harmed by natural elements (such as Hurricane Beryl in the Atlantic Ocean). Demand‑side shocks could act in the opposite direction in the event of a slower economic recovery. Under the circumstances, the future decisions of OPEC+ members remain highly relevant.

Possible further price increases are also associated with spillovers from other energy markets. For instance, at international level, the economic sanctions on Russia’s trade in liquefied natural gas could bring about additional mark-ups on the global retail prices of this product. On the domestic front, increased short-term uncertainties stem from the future behaviour of natural gas providers. After a price hike by a major supplier in June, adjustments to the upside by other providers are not ruled out over the coming months. In the longer run, uncertainties are attributed to the prices prevailing after the expiry of the electricity and natural gas price capping scheme on 31 March 2025.

Relative to other commodities, their future price movements will be particularly sensitive to weather conditions, in view of the increasingly violent manifestations in recent periods. For example, the persistent drought and an increased incidence of extreme events are likely to affect agricultural crops, with an impact on the supply of such goods. By contrast, while policies designed to tackle climate change in the medium term could also initially generate inflationary pressures, they are unlikely to significantly affect the eight-quarter horizon of the current projection.

Demand-side factors are further seen to have a rather disinflationary impact. The economic recovery could be stalled by adverse factors such as the protraction of tight financial conditions beyond the expectations formulated three months ago, the persistence of inflationary shocks or the volatility in energy prices. An additional weakening in aggregate demand could also come from the introduction of fiscal consolidation packages in a number of EU economies against the background of putting in place the new economic governance framework. Moreover, in the event of sluggish economic activity in China or the US, adverse spillovers are not ruled out. On balance, the overlapping of disinflationary demand-side drivers with inflationary supply-side shocks could hamper the future calibration of monetary policies. Depending on the specific balance of such risks in various economies, risks are also associated with possibly diverging monetary policy stances pursued by major central banks (ECB, Fed).