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; Eugen Nicolăescu, Board member and Deputy Governor of the National Bank of Romania; Liviu Voinea, Board member and Deputy Governor of the National Bank of Romania; Marin Dinu, Board member; Daniel Dăianu, Board member; Gheorghe Gherghina, Board member; and Virgiliu-Jorj Stoenescu, Board member.

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

Board members first noted that the annual inflation rate had stopped increasing in June, remaining at 5.4 percent, above the variation band of the target. Moreover, during Q2 as a whole, its rise had moderated significantly, in line with expectations, while the step-up versus March had been attributable to the action of supply-side factors, compounded on certain segments by the significant excess aggregate demand. The main influence had come from the marked increases, even above expectations, in fuel prices, amid costlier oil and the upward movements in the USD/RON exchange rate, with lower contributions from the hike in tobacco product prices and the rise in fruit and vegetables prices.

Core inflation had witnessed a slight deceleration during Q2, with the annual adjusted CORE2 inflation rate falling from 2.99 percent in March to 2.9 percent in June, slightly below the forecast. The slowdown had been ascribed to processed food and services prices, more strongly influenced by the dynamics of international prices of some agri-food items and by the movements in the EUR/RON exchange rate, with non-food prices exerting opposite effects. Some Board members held the view that the developments pointed to a levelling-off, at least temporarily, of demand-side inflationary pressures, consumer demand pressure in particular. Nevertheless, short-term inflation expectations had further moved upwards, the annual dynamics of industrial producer prices for consumer goods had regained momentum in June, while the annual pace of increase of unit wage costs in industry had stuck to an uptrend in the first two months of Q2, amid slower labour productivity growth.

In that context, reference was made to the high degree of labour market tightness, but also to the flattening trend of its curve as suggested by recent developments in specific indicators, as well as by the findings of specialised surveys. The general opinion was that pressures on wages would remain elevated, owing inter alia to higher difficulties in recruiting personnel, which highlighted the market’s structural weaknesses. Mention was made of the renewed step-up in the annual growth rate of average gross nominal wage earnings April through May, after four consecutive quarters of slight slowdown when it had stuck, however, to two-digit levels. The evolution characterised the private sector as well, but was more visible in the public sector, given the significant pay rises in healthcare and education. Members also observed the renewed pick-up during that period in the annual dynamics of the average real net wage, even amid the faster annual inflation rate.

Turning to the cyclical position of the economy, Board members noted that the second provisional version of data on GDP developments further pointed to the stronger-than-anticipated deceleration of economic growth to 4 percent in Q1, from 6.7 percent in 2017 Q4, given the only marginal upward revision of its quarterly dynamics. Some Board members considered that evolution to be a welcome return towards the potential rate of economic growth, since it implied a contraction in excess aggregate demand. It was remarked that the new data showed some differences in the composition of economic growth drivers on the demand side, with a slight downward correction in the prevailing, albeit diminishing, contribution of household consumption and a slight upward revision of the decreasing positive contribution of gross fixed capital formation. Net exports had made a considerably more negative contribution than in the previous quarter, in the context of a merely marginal deceleration in the annual dynamics of imports of goods and services, leading to the widening in annual terms of the negative balance on trade in goods and services in 2018 Q1. On the supply side, the composition of economic growth drivers had practically remained unchanged, with services further acting as the main contributor, followed by industry.

Board members remarked that the deceleration of economic expansion was expected to continue in Q2 and Q3, exclusively on account of base effects, while the quarterly pace of growth was anticipated to regain traction compared to the first three months of the year. It was observed that the evolution would likely prompt the positive output gap to re-embark on a slight uptrend in Q2, after the decline seen in the previous period, although posting lower values than in the earlier forecast. It was concluded that the latest developments in high-frequency indicators pointed to private consumption as the engine of economic growth in Q2 as well, but also the main culprit for its slowdown. Gross fixed capital formation was expected to make a lower positive contribution. By contrast, the contribution of net exports could become positive again, given that the gap between the annual growth rate of exports of goods and that of imports had almost closed during the first two months of Q2, leading to slower growth in the negative balance on trade and contributing to a near-halt in the deepening of the current account deficit versus the same year-earlier period.

Looking at financial market developments, Board members deemed that monetary conditions had continued to be less accommodative in the recent period. Some members underlined the rise in relevant interbank money market rates substantially above the policy rate in July, which was tantamount to a less accommodative monetary policy stance than that indicated by the NBR’s key interest rate; the downtrend in the EUR/RON exchange rate was also pointed out, amid the relative improvement in global risk appetite and the larger differential of interest rates on the local market. Those evolutions could witness slight corrections in the context of the central bank providing liquidity via the recently launched repos. Reference was also made to the renewed notable rise in the average interest rate on new time deposits in June – attributable, however, to a small extent to household deposits – and to the standstill in the average lending rate on new business, implying a further narrowing of the spread between them; the evolution might continue in the near run, against the background of the pass-through of the recent hikes in interbank money market rates.

At the same time, Board members observed that the annual growth rate of credit to the private sector had stepped up further in June, to 6.8 percent, thus exceeding in Q2 the averages of the previous two quarters. The stronger momentum had continued to be underpinned by consumer credit, whose dynamics had followed a steeper uptrend, in correlation with the evolution of wage earnings, the main contribution coming however from loans to non-financial corporations. The domestic currency component had further widened its share in total private sector credit to 65 percent in June, a welcome evolution in terms of the robustness of the economy.

When discussing future developments, Board members showed that the new anticipated pattern of inflation was quasi-similar over the short term to that forecasted in the May 2018 Inflation Report, but slightly revised downwards over the longer time horizon. Specifically, after the May-June 2018 peak, the annual inflation rate was expected to decline and remain in Q3 slightly below 5 percent, before dropping more steeply and returning to the 3.5 percent upper bound of the variation band of the target in December 2018, slightly below the previous forecast. In 2019, after a new downward correction at the onset of the year, the annual inflation rate would probably tend to gradually near the central target and then re-enter a slowly upward path in Q4, running however below the previously forecasted values, to reach 2.8 percent at the end of the projection horizon, i.e. June 2020, compared with 3.0 percent in the earlier projection.

It was concluded that the future downward adjustments of the annual inflation rate, as well as its likely temporary fall in the vicinity of the central target were ascribable to the action of supply-side factors, especially to the disinflationary base effects associated with the sizeable increases recorded starting with 2017 H2 by all exogenous CPI components, but also by some processed food prices. Reference was made to the simultaneous or successive rises seen in the previous quarters by electricity and natural gas prices, fuel and tobacco product prices, as well as by prices for vegetables, fruit and eggs. Mention was also made of the new disinflationary influences stemming from the decline in electricity prices in July 2018, as well as from the announced reduction on 1 January 2019 in the VAT rate for sewerage and heating, only partly counterbalanced over the short term by the effects of higher natural gas prices starting August 2018. In that context, some members pointed out the uncertainties related to the future configuration of the indirect tax system, as well as to the outlook for administered prices, volatile food prices and prices of processed food items, but also to the likely evolution of oil prices, entailing risks to the current inflation prospects, inter alia via possibly affecting medium-term inflation expectations, assuming the protracted deviation of the annual inflation rate from the upper bound of the variation band.

Board members remarked that core inflation was also expected to calm down over the short time horizon, before climbing again during 2019, although remaining somewhat more moderate than previously forecasted. In particular, the annual adjusted CORE2 inflation rate was anticipated to stand at 2.6 percent in December 2018, but to gradually rise afterwards and level off at 3.2 percent by the end of the forecast horizon, compared with the earlier projection, which had seen it at 3.2 percent in December 2018 and 3.4 percent in December 2019. It was agreed that, over the short time horizon, its anticipated path reflected the fadeout of the impact exerted on processed food prices by the increase, towards the end of the previous year, in the prices of some agri-food commodities and the abatement at the beginning of 2018 of inflationary pressures from the cyclical position of the economy. However, those pressures were expected to gradually become manifest again starting 2019 Q2 and to remain significant thereafter, given that – after the narrowing seen in 2018 Q1 – the positive output gap would probably re-embark on an uptrend extending until mid-2019, its magnitude thus exceeding marginally the previously-forecasted one at the end of the projection horizon. Moreover, it was observed that slightly stronger inflationary pressures – even than in the May projection – were anticipated to stem, throughout the forecast horizon, from the trend in short-term inflation expectations, as well as from the progressively rising dynamics of import prices.

Assessing the likely pattern of excess aggregate demand, Board members noted that the new medium-term forecast anticipated a stronger-than-previously-projected moderation of economic growth in 2018, followed however by a renewed pick-up in 2019, and hence by a return of its annual rate towards potential. It was shown that the outlook implied a marked abatement, also in relation to the previous forecast, of the expansionary nature of the fiscal policy in 2018, which was then seen becoming neutral in 2019, as well as the deceleration – albeit more moderate than previously anticipated – in the dynamics of households’ real disposable income. The outlook also assumed a somewhat slower reduction in the degree of accommodation of monetary conditions over the projection horizon and a relative improvement in EU funds absorption, based inter alia on the hypothesis of stronger economic growth in the euro area/EU and globally than in the previous forecast. In some Board members’ opinion, the outlook for the European economy was, however, further surrounded by uncertainties, given the risks induced – also via affecting investor confidence – by protectionist trade policies, although alleviated at least temporarily by the outcome of the recent talks between US and EU representatives. Notable uncertainties and risks were also deemed as stemming from Brexit talks and implementation, as well as from fluctuations in global financial market volatility. The monetary policy stances of the major central banks and the macroeconomic environment in which they operate were implicitly touched upon, increasing relevance being attached to the approach of the ECB and that of central banks in the region. Against that background, reference was made to the relevance of policy rate differentials in judging the monetary policy stance. The urge for a balanced macroeconomic policy mix was reiterated, deemed essential also from the standpoint of avoiding the overburdening of monetary policy and preventing undesired effects in the economy.

According to Board members’ assessment, household consumption would likely remain the key driver of economic growth in 2018 and 2019, but also the component whose dynamics would witness the most significant deceleration this year. From that perspective, it was agreed that major sources of uncertainties and risks to the current inflation forecast remained household confidence and the future dynamics of households’ real disposable income, inter alia amid labour market tightening, the recent rises in certain income categories, and the further relatively high – albeit declining – annual inflation rate. Mention was also made of the increases in consumer credit flows in the recent period and the strong demand for such loans, correlated with developments in wages, but also of the uncertainty surrounding the related outlook.

Board members voiced concerns over the recent and likely developments in gross fixed capital formation, whose contribution to the dynamics of economic activity was anticipated to be, in 2018 as well, markedly more modest than that of consumption and declining significantly versus the previous year, with implications for the internal and external equilibria of the economy. Reference was made to EU funds absorption, to the composition of budget expenses unfavourable for public investment and to its outlook, also in the context of the envisaged budget revision, as well as to the legislative initiatives on the banking sector, with a potential adverse impact on lending to non-financial corporations. At the same time, the significantly improved prospects of net exports were remarked, amid the likely more pronounced slowdown in the growth rate of imports than that of exports, conducive to putting a break on the increase in the current account deficit as a share of GDP. In that context, most Board members reiterated the importance of an adequate dosage and pace of adjustment of the monetary policy stance, from the perspective of anchoring inflation expectations and maintaining the annual inflation rate on the trajectory shown by the NBR’s medium-term forecast, while safeguarding financial stability.

Under the circumstances, the NBR Board unanimously decided to keep unchanged the monetary policy rate at 2.50 percent, the deposit facility rate at 1.50 percent and the lending (Lombard) facility rate at 3.50 percent. In addition, the NBR Board unanimously decided to maintain the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions.