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 decision, based on the data and analyses on current and future macroeconomic, financial and monetary developments submitted by the specialised departments, as well as on other available domestic and external information.

Looking at the recent developments in inflation, Board members showed that the annual inflation rate had increased faster than expected in the first two months of 2022 Q2 amid a high jump in April to 13.76 percent from 10.15 percent in March, followed by a moderate advance in May to 14.49 percent. It was noted that most of the increase had been yet again triggered by exogenous CPI components, especially by the hefty and larger-than-anticipated hikes in electricity and natural gas prices, given the changes made to the price capping schemes starting in April. Higher-than-expected, yet modest influences had stemmed from a further pick-up in fuel prices, under the impact of the steep rise in crude oil prices, in the context of the war in Ukraine and the associated sanctions, as well as from the higher prices of some public utilities, reflecting the surge in energy prices.

In turn, the annual adjusted CORE2 inflation rate had risen more steeply in the first month of Q2, also compared to forecasts, with its upward trend however softening subsequently, and had reached 9.1 percent in May from 7.1 percent in March. Board members noted that the advance had continued to be mainly driven by processed food prices, to an even significantly higher extent compared to the previous quarter, which had thus touched a record high. By contrast, the contribution from the services sub-component had dropped to the lowest level in 12 months – probably reflecting inter alia the evolution in annual terms of the EUR/RON exchange rate –, while the contribution of the non-food sub-component had also contracted, albeit more moderately, given that the range of items having posted a slower increase in the annual change had exceeded that of goods whose pick-up in price dynamics had seen a mild acceleration.

Following the analysis, Board members agreed that the further relatively fast upward trend of the annual adjusted CORE2 inflation rate was still ascribable to global supply-side shocks, amplified by the war in Ukraine and the sanctions imposed. Their direct and indirect inflationary effects had continued to be 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. Members underlined in that context the global magnitude of the strong inflation caused by global supply-side shocks, which had driven the dynamics of consumer prices to unprecedented levels over the last decades in developed economies, including in many European countries.

At the same time, they emphasised the notably swifter growth rates seen in March-April by producer prices in manufacturing, including the consumer goods segment – under the influence of higher costs of energy and other commodities, especially agri-food items, as well as amid persistent bottlenecks in production and supply chains –, likely to continue to pass through gradually into the prices of some consumer goods and services, but also depending on demand conditions. Members also stressed the economic agents’ high or rising short-term inflation expectations over the last months, accompanied by a yet significantly less visible adjustment in financial analysts’ longer-term inflation expectations, as well as the erosion trend of the consumer purchasing power, reflected in the dynamics of the average real net wage re-entering negative territory at the beginning of Q2.

As for the cyclical position of the economy, Board members remarked that in 2022 Q1 the economic activity had seen a much stronger-than-expected step-up, expanding by 5.2 percent against 2021 Q4, when it had added 1.0 percent against the previous quarter. It was concluded that the developments rendered likely a visibly higher-than-expected resurgence in positive output gap in that period, albeit relatively moderate, given, inter alia, the implications of the recent revision of statistical data on quarterly GDP growth rates.

The annual economic growth rate had also seen a significantly stronger-than-anticipated increase in 2022 Q1 to 6.4 percent, after the large declines in the second half of 2021 to 2.4 percent in 2021 Q4. However, behind the strengthening in GDP growth rate had stood mainly the change in inventories, while the contribution of private consumption – coming second in terms of size – had owed to some sub-components playing a secondary part and accounting for a relatively low share, whereas purchases of goods and services had posted a considerably slower annual pace of increase during that period, inter alia amid a base effect, Board members noted.

A notable positive contribution to growth had also been made by gross fixed capital formation – as a result of the strong re-acceleration, in annual terms, of both net investment in equipment (transport equipment included) and new construction works –, while another more modest contribution had come from net exports. During Q1, net exports had no longer made a negative contribution to annual GDP dynamics, as the increase in the annual change in the export volume of goods and services had outpaced that in the import volume.

However, the annual increase in the negative trade balance had re-accelerated, primarily amid the relatively more unfavourable developments in import prices, while the current account deficit had seen a considerably faster deepening trend against the same period of the previous year, inter alia as a result of the strong worsening in the dynamics of the primary income balance, on account of outflows of reinvested earnings and distributed dividends. Although partly attributable to incidental factors, the trends were viewed as particularly worrisome by Board members, given also the visible drop against end-2021 in the coverage of the current account deficit by foreign direct investment and capital transfers.

Looking at labour market developments, Board members discussed the latest developments in the relevant indicators showing a tightening in the market. Thus, it was noted that the mild pick-up in the growth rate of the number of employees economy-wide in March-April had been almost entirely attributable to the private sector and had been accompanied by a gradual decline in the unemployment rate to 5.4 percent in May – from 5.8 percent in January 2022 –, a level which remained however visibly above pre-pandemic ones. Furthermore, the labour shortage reported by companies had posted a faster rise in Q2, tending to near the levels prevailing prior to the pandemic, while the hiring intentions for the near-term horizon had increased, but in the context of mixed sectoral developments, probably explained mostly by the effects and uncertainties generated by the war in Ukraine and the sanctions imposed.

At the same time, average gross nominal wage earnings had recorded a significantly faster annual growth rate over the last months to a two-digit level in April, and almost entirely on account of developments in the private sector, without matching, however, the inflation rate. The swift annual dynamics of the unit labour cost in industry had seen an even faster tempo particularly in April, which was viewed as worrisome by some Board members in spite of its being largely attributed to the marked decline in annual terms in labour productivity in recent months amid bottlenecks in production chains and elevated energy and commodity costs.

In that context, some Board members referred to the high inflation rate and the recent measures on the hike in the gross minimum wage in certain sectors, but also to the wage increases in the public sector pending enactment into law, likely to speed up the dynamics of some wages in the near run. Across the economy as a whole, such a trend was however expected to be slowed down by the constraints on firms as a result of high energy, transport and commodity costs, as well as by the effects and heightened uncertainties generated by the protraction of the war in Ukraine and the imposition of new sanctions, with an impact on demand too, several Board members deemed.

Over a somewhat longer horizon, the ability of some businesses to remain viable/profitable, in the context of high costs, would probably be challenged also by the cessation of government support measures, as well as by the need for technology integration, possibly leading to new restructuring or bankruptcy of firms. Moreover, notable uncertainties stemmed from the expansion of automation and digitalisation domestically, alongside a higher resort to workers from outside the EU.

Turning to financial market conditions, Board members highlighted the faster pace of increase in the main interbank money market rates in the recent period, prompted by the larger increment of the monetary policy rate hike in May and by the central bank’s firm control over market liquidity, but also amid expectations on a rise in the key rate, strengthened by the NBR’s messages and the decisions of central banks in the region. It was shown that yields on government securities had, in turn, steepened their upward path, especially for the short and medium maturities. This had occurred, inter alia, in the context of a brief sell-off episode on bond markets, entailed by expectations on a faster normalisation of the monetary policy conduct by the Fed and the ECB, as well as amid the more pronounced deterioration of financial investor sentiment vis-à-vis the region. Under the influence of those developments, as well as following the heftier rise in the IRCC at the onset of Q2, the average lending rate on new business and the average remuneration of new time deposits had grown at a considerably swifter tempo in April and May. The advance had been markedly stronger in the latter case, reflecting also the increases seen for households, so that the spread between the two types of average interest rates had reached a historical low in May, some Board members noted.

At that juncture, the EUR/RON exchange rate had remained relatively stable in May and June as well, with favourable implications for inflation and confidence in the domestic currency. However, risks to exchange rate developments could rise again and could affect also external vulnerability indicators, several members cautioned. They referred to the widening external imbalance and the uncertainties associated with budget consolidation, 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.

At the same time, Board members observed that the lending process had remained fast-paced in the first two months of Q2, inter alia amid firms’ higher working capital financing needs in the current context. Therefore, the double-digit annual growth rate of credit to the private sector had stepped up further, reaching 16.5 percent in May, as the particularly strong dynamics of the leu-denominated component had remained relatively steady – with a rising, albeit somewhat modest contribution from government programmes – and had been accompanied by a renewed pick-up in the pace of increase of forex loans. The same as in the previous months, the added momentum had been almost entirely attributable to corporate loans, but that time around with the contribution of both components. Overall, the share of leu-denominated loans in credit to the private sector had remained unchanged at 72.7 percent.

Conversely, broad money had seen further declines in its annual dynamics during that period, alongside obvious structural changes, especially in May, which might consolidate in the near future, several Board members remarked. According to the opinions voiced, behind those developments stood household portfolio shifts towards government securities, associated with reallocations of household and corporate liquidity holdings towards time deposits in lei – amid the faster increase in related interest rates –, but also the likely temporary release of previously pent-up demand, particularly for international tourism services.

As for future developments, Board members showed that, according to the new assessments, the annual inflation rate would stick to an upward path until mid-Q3, yet at a visibly slower pace, thus climbing moderately above the values envisaged over the short time horizon by the latest medium-term forecast. It was reminded that the May forecast had anticipated a 14.2 percent peak of inflation dynamics for June 2022, followed by an only gradual decrease over four quarters, yet brisker afterwards, implying that the inflation rate would fall to single-digit levels no sooner than 2023 H2 and would stay above the variation band of the target at the end of the projection horizon, at 6.2 percent.

The renewed worsening of the near-term inflation outlook continued to be attributable to global supply-side shocks, Board members repeatedly underlined. They noted that the major drivers were the higher dynamics anticipated over the following months for the prices of fuels, natural gas and electricity – even amid the support schemes in place and some base effects –, as well as for processed food prices, mainly under the influence of the stronger advance in crude oil, energy and agri-food commodity prices, owing to the war in Ukraine and the associated sanctions. Additional inflationary effects were also expected from administered prices, inter alia as a result of the National Railway Company raising ticket prices, as well as from tobacco product prices, following the increase in the specific excise duty. It was observed that, under the circumstances, the additional inflationary effects – both direct and indirect – of global supply-side shocks would affect in the period ahead both the evolution of exogenous CPI components and core inflation dynamics, albeit with a much lower intensity than in previous quarters, especially in the latter case.

It was agreed, at the same time, that the outlook for the impact and duration of energy price capping schemes was further marked by uncertainty, while similar uncertainties were associated with the fuel price compensation measure, presumed to be applied July through September 2022. Looking at the overall balance of supply-side risks to the inflation outlook, however, upside risks continued to prevail, at least in the short run, inter alia amid the recently announced fiscal measures for increasing budget revenues. Nevertheless, Board members concluded that small downward corrections in some international commodity prices, particularly agri-food, as well as somewhat more obvious improvements across global production and supply chains were also possible.

Some members deemed that, in such a context, anchoring inflation expectations over the medium term and preventing the start of a self-sustained rise in the overall level of consumer prices – possibly via a wage-price spiral – called for a renewed increase in the key rate, especially as the labour market tended to tighten. Such a response was also warranted from the perspective of central bank credibility, according to several Board members.

At the same time, it was observed that the cyclical position of the economy was envisaged to exert modest inflationary pressures and abating in the near run, although stronger than previously anticipated, as the new assessments pointed to a quasi-standstill of economic activity in Q2 and Q3, under the impact of the war in Ukraine and the associated sanctions, yet after much faster-than-expected GDP growth in Q1. The evolutions rendered it likely for excess aggregate demand to shrink during Q2 and Q3, but run visibly higher than forecasted in May 2022.

Developments also implied a considerable decrease in the annual dynamics of economic activity during Q2, followed by a renewed pick-up in Q3, on account of a base effect, but also significantly higher-than-previously-forecasted levels of those dynamics, as a result of GDP growth way above expectations in Q1, Board members remarked.

Moreover, it was noted that high-frequency indicators suggested a significant temporary pick-up in private consumption dynamics during Q2 versus the same year-earlier period, primarily on the back of a base effect, but also amid the release of pent-up demand, especially in the services segment. Conversely, opposite developments were possible in the case of gross fixed capital formation, likely to contribute decisively to the decline in annual GDP dynamics in Q2, considering particularly the sizeable drop in the volume of construction works in April against the same period of 2021. At the same time, the contribution of net exports to annual GDP dynamics could become again slightly negative, as the annual change in exports of goods and services had diminished considerably in April and much more steeply than that in imports, inter alia amid unfavourable developments in external prices. Consequently, the trade deficit had seen its annual dynamics expand more than twofold versus the Q1 average, while the current account deficit had further increased swiftly in annual terms, even in the context of a slight improvement in the evolution of the primary income balance.

It was repeatedly shown that the protraction of the war in Ukraine and the expansion of sanctions against Russia generated considerable uncertainties and risks to the outlook for economic activity, hence to medium-term inflation developments, through the possibly stronger effects exerted, via multiple channels, on consumer purchasing power and confidence, as well as on firms’ activity, profits and investment plans, but also by potentially affecting more severely the European/global economy and the risk perception towards economies in the region, with an unfavourable impact on financing costs.

Against that background, Board members were of the opinion that it was vital to reap the full benefits of EU funds allocated to Romania, especially those under the Next Generation EU programme. The absorption of those funds was essential for speeding up structural reforms, energy transition included – given also the nature of conditionalities attached to the process –, but also for counterbalancing, at least in part, the contractionary impact of the sizeable global supply-side shocks, as well as the effects of fiscal consolidation.

The uncertainties and risks associated with the future fiscal policy stance were, however, on the rise, Board members agreed. They referred to the budget execution so far and the requirement for further fiscal consolidation amid the excessive deficit procedure and the tightening trend of financing conditions. At the same time, they highlighted primarily the current challenging economic and social environment domestically and globally, as well as the recently-implemented packages of support measures for households and firms, with potential adverse implications for budget parameters.

Following the overall analysis, Board members were of the unanimous opinion that such a context called for a 1.00 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. From that perspective, they underlined the importance of the dosage of measures and of the calibration of the monetary policy conduct at the current juncture to avoid, as much as possible, a significant slowdown of economic growth, given also the major contractionary effects generated by the sizeable supply-side shocks, the energy crisis in particular, but also the requirement for fiscal consolidation progress.

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 4.75 percent from 3.75 percent. Moreover, it decided to raise the lending (Lombard) facility rate to 5.75 percent from 4.75 percent and the deposit facility rate to 3.75 percent from 2.75 percent. At the same time, the NBR Board unanimously decided 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.