The National Bank of Romania Board members present at the meeting: Mugur Isărescu, Chairman of the Board and Governor of the National Bank of Romania; Florin Georgescu, Vice Chairman of the Board and First Deputy Governor of the National Bank of Romania; Leonardo Badea, Board member and Deputy Governor of the National Bank of Romania; Eugen Nicolăescu, Board member and Deputy Governor of the National Bank of Romania; Csaba Bálint, Board member; Gheorghe Gherghina, Board member; Cristian Popa, Board member; Dan-Radu Rușanu, Board member; Virgiliu-Jorj Stoenescu, Board member.

During the meeting, the Board discussed and adopted the monetary policy decisions, based on the data on and analyses of recent macroeconomic developments and the medium-term outlook submitted by the specialised departments, as well as on other available domestic and external information.

Looking at the recent developments in inflation, Board members noted that the new surge in the annual inflation rate in March 2022 to 10.15 percent from 8.53 percent in February had been driven by the stronger pick-up in processed food and fuel prices, under the impact of the sharp rise in agri-food commodity and crude oil prices, once with the outbreak of the war in Ukraine and the imposition of international sanctions. The annual inflation rate had thus recorded a significant, higher-than-expected increase in 2022 Q1 too, from 8.19 percent in December 2021. The exogenous CPI components had made, however, a far more modest contribution, as the slower growth rates of electricity and natural gas prices amid the capping schemes for households’ energy bills had largely offset the influences of the strong rises in fuel and VFE prices.

Conversely, the annual adjusted CORE2 inflation rate had followed a notably sharper upward path, also compared to forecasts, to reach 7.1 percent in March from 4.7 percent in December 2021. Nevertheless, two thirds of the advance had been further attributable to processed food prices, given significantly faster-than-expected broad-based increases in prices, under the impact of the steep hikes in commodity, energy and transport costs, especially following the outbreak of the war in Ukraine, as well as of a relatively higher pass-through of energy costs in that segment, several Board members showed. The visibly more modest contributions made by the non-food and services subcomponents had been however slightly higher than in the previous quarter, given the broader scope and faster pace of price increases. That had most likely been in correlation with a stronger rise in import prices and domestic production costs, coupled with a still strong demand for certain services, inter alia amid the lifting of mobility restrictions in March.

Following the analysis, Board members agreed that the faster upward movement of annual core inflation rate in Q1 was also ascribable to global supply-side shocks, amplified by the outbreak of the war in Ukraine and the sanctions imposed. Their direct and indirect effects had been compounded domestically by the high short-term inflation expectations, the resilience of demand in certain segments, as well as by the significant share of food items and imported goods in the CPI basket. In that context, it was shown that high and rising inflation dynamics were a European and even a global phenomenon, and that sharp rises in the annual inflation rate, core inflation included, had been lately reported by many countries in Europe and by the USA, amid an unprecedented economic and geopolitical situation in recent decades.

At the same time, Board members underlined the notably swifter growth rates of industrial producer prices across Europe and domestically after the outbreak of the military conflict – amid the even sharper increases in energy and other commodity costs, particularly agri-food costs, and tighter bottlenecks in global value chains –, likely to pass further through into the prices of almost all consumer goods and services, depending also on demand conditions. Reference was also made to the substantial rises in economic agents’ short-term inflation expectations in early Q2, accompanied by a however small adjustment in financial analysts’ longer-term inflation expectations, as well as to the government measures applied in the current year to protect consumer purchasing power that would underpin, alongside larger social transfers, the recovery of the dynamics of households’ real disposable income in the first months of 2022.

As for the cyclical position of the economy, Board members remarked that the new preliminary version of statistical data reconfirmed the fall by 0.1 percent in economic activity in 2021 Q4 against the previous quarter, on the back of the marked deterioration in the performance of agriculture, which caused excess aggregate demand to remain low during that period, in line with the February 2022 forecast, inter alia as a result of the recent revision of statistical data on GDP developments in 2020 and 2021.

Moreover, the magnitude of the decline in annual GDP dynamics was reconfirmed, i.e. to 2.4 percent in 2021 Q4 from 6.9 percent in the previous quarter, on account of the notable loss of momentum of the change in inventories, whereas the marked deceleration in the dynamics of household consumption and gross fixed capital formation had been counterbalanced, in terms of impact, by the strong acceleration in the annual growth of general government consumption. At the same time, net exports had seen their contractionary impact diminish over that period, as the annual dynamics of the import volume of goods and services had declined faster than those of the export volume. Against that background, the annual increase in the negative trade balance had decelerated considerably as against Q3, due also to the narrowing of the unfavourable differential between the change in import prices and that in export prices. However, the current account deficit had widened in annual terms at a significantly faster pace, under the impact of the worsening of the secondary income balance, with its share of GDP climbing consequently to 7.0 percent in 2021 as a whole, from 5.0 percent in 2020.

As for the near-term outlook, Board members agreed that a re-acceleration of economic growth in 2022 Q1 was likely, followed however by a possible quasi-standstill in Q2, under the impact of the war in Ukraine and the associated sanctions. The developments implied low values of excess aggregate demand in the first part of the current year and on a decline in Q2, especially compared to the previous forecasts, as well as a further slowdown in the annual dynamics of GDP amid a protracted base effect.

It was noted that, according to the latest high-frequency indicators, the likely deceleration in the annual economic growth in Q1 had mainly been driven by private consumption, while opposite influences might have come from gross fixed capital formation but also from net exports, given that the somewhat stronger advance posted in January-February 2022 by the annual change in imports of goods and services as compared to that in exports had reflected chiefly the unfavourable effect of developments in external prices. However, that had led to an almost double annual growth rate of trade deficit against 2021 Q4, as well as to a faster annual increase in the current account deficit, both viewed as worrisome by Board members, in spite of being largely attributable to the worsening of the terms of trade.

Looking at the labour market, Board members underlined the partly divergent developments seen in recent months, reiterating the need for a further close monitoring of market parameters. It was pointed out that the number of employees economy-wide had continued to post a mild rise in the first two months of 2022, yet amid uneven developments across sectors, while the ILO unemployment rate had remained flat at 5.7 percent in Q1, visibly above pre-pandemic values and significantly above the historical low recorded in August 2019. At the same time, it was noted that the annual rate of increase of the average gross wage earnings and that of unit labour cost in industry had reached significant levels in the first two months of the year, but owing to a great extent to a base effect and a slow advance in labour productivity, respectively, in the context of bottlenecks in production chains and elevated energy and commodity costs. The labour shortage reported by companies had continued however to see a faster rise in early Q2, while remaining considerably below its pre-pandemic peak. The hiring intentions for the near-term horizon had rebounded in April, especially in trade and services – also probably owing to the lifting of mobility restrictions –, but had seen a more modest pick-up in industry.

It was deemed that, in that context, stronger upward wage pressures, primarily substantiated by the inflation dynamics, could become manifest particularly in sectors facing chronic labour shortage. A relatively moderate increase was expected in the private sector overall, against the background of the demonstration effect from the wage policy assumed to be maintained in the public sector in the current year, but especially of the constraints stemming from companies’ notably higher energy, transport and commodity costs. From that perspective, Board members viewed also as relevant the high uncertainties and risks posed, at least in the near future, by the war in Ukraine and the sanctions imposed on Russia, likely to worsen the energy crisis and the disruptions in production and supply chains and to trigger a faster pick-up in the prices of other commodities, especially agri-food items. However, their impact on labour market parameters would likely be mitigated by the government measures to maintain employment relationships and support companies in the current context, according to several Board members.

Over the longer time horizon, uncertainties lingered nevertheless associated with the ability of some businesses to remain viable after the cessation of government support measures, as well as in the context of high costs of energy and other commodities, but also of the need for technology integration, possibly leading to restructuring or bankruptcy of some firms. The implications of the expansion of automation and digitalisation, as well as those of a higher resort to workers from outside the EU were also relevant for future labour market conditions.

Turning to financial market conditions, Board members highlighted the fast-paced rise of the main interbank money market rates in the recent period, prompted by the monetary policy rate hike in April and by the tightening of liquidity conditions amid the central bank’s firm control, as well as by expectations on the immediate path of the key rate. Reference was also made to the steeper rises in yields on government securities, inter alia under the influence from a renewed deterioration of financial investor sentiment vis-à-vis markets in the region, given the war in Ukraine, but also from the expectations on a relatively swifter interest rate increase by the Fed and by other major central banks.

Moreover, members underlined that the EUR/RON exchange rate had remained relatively stable in April as well, with favourable implications for inflation and confidence in the domestic currency. However, risks to exchange rate developments were on the rise and with potential adverse consequences also for external vulnerability indicators, Board members deemed. They referred to the size of the external imbalance and the uncertainties associated with budget consolidation amid the war in Ukraine, to the Fed’s and the ECB’s prospective monetary policy stances, as well as to the significant local interest rate differential vis-à-vis countries in the region, given the ongoing swift increases in key rates by central banks in Czechia, Poland and Hungary.

Mention was also made of the average remuneration of new time deposits, which had witnessed a considerably faster rise in March, much steeper than interest rates on the main types of new loans. Members also pointed out their significantly negative real levels, which mirrored however a broad-based evolution, at least in Europe, amid particularly high inflation dynamics driven by supply-side shocks. At the same time, it was noted that lending had stepped up strongly in the closing month of Q1, as leu-denominated credit to non-financial corporations and housing loans had posted record flows, inter alia with a rising – albeit relatively modest – contribution from government programmes. The annual growth rate of credit to the private sector had seen, however, its pick-up come to a halt, yet at a particularly high level, i.e. 15.7 percent, while the share of leu-denominated loans in total had widened to 72.7 percent.

As for future macroeconomic developments, Board members showed that the updated assessments indicated a renewed considerable worsening of the inflation outlook across the entire forecast horizon. Specifically, the annual inflation rate was expected to accelerate its growth in 2022 Q2 – to 14.2 percent in June versus 11.2 percent in the earlier projection – and decline only mildly in the next four quarters, to stand at 12.5 percent in December 2022 and 12.4 percent in June 2023, well above the previously-forecasted 9.6 percent and 5.0 percent respectively. At the same time, after a relatively steep downward adjustment probably witnessed subsequently due to sizeable base effects, it was anticipated to decrease progressively and remain at 6.2 percent at the end of the projection horizon, significantly above the variation band of the target and the February forecast of 3.2 percent.

The worsening of the inflation outlook continued to be attributable to global supply-side shocks, compounded and protracted by the war in Ukraine and by the sanctions imposed on Russia, Board members repeatedly underlined. They remarked that the main determinants were the much higher increases expected for processed food and fuel prices, as well as for natural gas and electricity prices, primarily under the influence of the sharper rise in agri-food and energy commodity prices.

At the same time, it was observed that the anticipated inflationary impact of the more sizeable increase in energy prices would be considerably cushioned by the capping schemes presumed to be applied until March 2023. However, it would become strongly manifest afterwards, counterbalancing in part and temporarily the opposite influences from base effects and from probable downward corrections in energy commodity prices. Against that background, the downward path of the annual inflation rate was expected to come to a halt and reverse abruptly in April 2023, before resuming thereafter and steepening in mid-2023; nevertheless, the annual inflation rate would not return inside the variation band of the target at the end of the forecast horizon, Board members noted. Moreover, it was concluded that, under the circumstances, additional inflationary effects from supply-side shocks would concentrate over the short term on the core inflation component, given inter alia the large share held by processed food items in the latter’s basket.

At the same time, it was agreed that the impact presumed to be exerted by support schemes on CPI dynamics was marked by uncertainty. Furthermore, the overall balance of supply-side risks to the inflation outlook remained tilted to the upside, at least in the short run, amid the protracted war in Ukraine and the associated sanctions, with potential more severe implications for energy and non-energy commodity prices, mainly of agri-food, as well as for production and supply chains.

Following the analysis, Board members unanimously stated that such a context called for a renewed increase in the size of the key rate hike, in order to anchor inflation expectations over the medium term and prevent the start of a self-sustained rise in the overall level of consumer prices – possibly via a wage-price spiral –, but also from the perspective of central bank credibility. At the same time, it was reiterated that any potential central bank attempt to ward off the particularly strong direct and indirect inflationary effects of adverse supply-side shocks would be not only ineffective, but even counterproductive, in view of the sizeable losses it would cause to economic activity and employment over a longer horizon.

Underlying inflationary pressures were, however, anticipated to be subdued and gradually fading, implicitly softer than those in the earlier projection, given the slightly lower-than-expected economic growth during 2021 overall and the prospects for its sharper slowdown in 2022-2023 compared to previous forecasts. Hence, Board members concluded that those developments would render likely a gradual narrowing of the aggregate demand surplus in the next two years to almost zero.

Conversely, Board members remarked that core inflation dynamics would continue to be strongly affected in the short run by the sizeable inflationary effects of supply-side shocks, further compounded by high short-term inflation expectations and by the significant share of imports in the core inflation basket. Such effects were expected to stem primarily from much more sizeable hikes in agri-food commodity prices, as well as from the surge in energy prices and the worsening of supply-side disruptions. Under the circumstances, the annual adjusted CORE2 inflation rate would probably continue to increase until end-2022, although at a much slower pace in H2, climbing to 10.9 percent in December, well above the previously-anticipated level. Afterwards, it would embark on a visibly more pronounced downward path than envisaged earlier, remaining however at 4.2 percent at the end of the projection horizon compared with the February forecast of 3.2 percent.

Looking at the future cyclical position of the economy, Board members observed that, after having reached very high dynamics from a historical perspective in 2021, yet slightly lower than anticipated, economic growth was expected to witness a considerable deceleration in 2022-2023 and significantly more pronounced than in previous forecasts. That owed to the impact of the war in Ukraine and the sanctions imposed, which would probably peak in 2022 and would be only partly counterbalanced by the effects from the absorption of EU funds under the Next Generation EU instrument. The evolution implied much lower-than-previously-estimated values of excess aggregate demand, gradually shrinking as of 2022 Q2 and nearing zero at the end of the projection horizon, even amid a renewed sizeable downward adjustment of potential GDP dynamics.

It was noted that private consumption would probably remain the major driver of GDP advance, given its relatively robust dynamics anticipated across the projection horizon, yet visibly more moderate in 2022 than previously forecasted. Behind those developments would stand particularly the step-up in inflation and the rise in households’ lending and deposit rates, but also the opposite influences coming especially from the lifting of mobility restrictions, the higher number of employees and from the influx of Ukrainian refugees.

Gross fixed capital formation could, nevertheless, see its growth come to a halt in 2022, before rebounding strongly the following year, amid the abatement of the war’s effects, Board members showed. Relevant from that perspective were deemed the heightened uncertainties and the effects generated in the short run by the war in Ukraine – especially via the softening of external demand, hikes in costs of materials, worsening of bottlenecks in production chains, and the tightening of financing conditions –, but also the probable increase in public capital expenditure, potentially in the energy and transport sectors as well, inter alia with a contribution from EU funds.

By contrast, net exports were likely to have an improved contribution to GDP growth as against previous years, even up to a marginally positive value in 2022, amid a somewhat more pronounced decline in the dynamics of the import volume of goods and services than in the case of the export volume. The current account deficit was, however, expected to widen as a share of GDP in 2022 as well, owing mainly to the further deterioration of the terms of trade, before shrinking only slightly the following year. Board members viewed those developments as worrisome, particularly in terms of potential adverse implications for inflation, the sovereign risk premium and, ultimately, for economic growth sustainability.

At the same time, it was repeatedly shown that the war in Ukraine and the sanctions imposed on Russia considerably compounded the uncertainties and risks to the economic outlook, and hence to medium-term inflation developments, through the effects potentially exerted, via multiple channels, on consumer purchasing power and confidence, as well as on firms’ activity, profits and investment plans, but also by affecting the European/global economy and the risk perception towards economies in the region, with an unfavourable impact on financing costs. Uncertainties and risks also stemmed from economic developments in China, amid the resurgence of the pandemic and the severe restrictions imposed, which could further weaken the global economy and international trade, especially via the worsening of bottlenecks in production and supply chains, several members underlined.

Furthermore, Board members reiterated their concerns about the outlook on the absorption of EU funds, especially those under the Next Generation EU programme. That was conditional on fulfilling strict milestones and targets, but was essential for accelerating structural reforms, energy transition included, as well as for counterbalancing, at least in part, the economic impact exerted by the war in Ukraine and by the fiscal consolidation.

The fiscal policy stance also remained, however, a major source of uncertainties and risks to the forecasts, Board members agreed. They highlighted, on one hand, the budget execution in the first months of the year and the requirement for further fiscal consolidation amid the excessive deficit procedure and the tightening trend of financing conditions and, on the other hand, the current challenging economic and social environment domestically and globally, strongly marked by the war in Ukraine and the sanctions imposed, with potential adverse implications for budget parameters.

Board members were of the unanimous opinion that the analysed context overall called for a 0.75 percentage point increase in the monetary policy rate, so as to anchor inflation expectations over the medium term and to foster saving, with a view to bringing back the annual inflation rate in line with the 2.5 percent ±1 percentage point flat target on a lasting basis, in a manner conducive to achieving sustainable economic growth.

Moreover, Board members advocated the need to maintain firm control over money market liquidity and reiterated the importance of further closely monitoring domestic and global developments, so as to enable the NBR to tailor its available instruments in order to achieve the overriding objective regarding medium-term price stability.

Under the circumstances, the NBR Board unanimously decided to increase the monetary policy rate to 3.75 percent from 3.00 percent. Moreover, it decided to raise the lending (Lombard) facility rate to 4.75 percent from 4.00 percent and the deposit facility rate to 2.75 percent from 2.00 percent, as well as to maintain firm control over money market liquidity. Furthermore, the NBR Board unanimously decided to keep the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions.