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; 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 showed that the annual inflation rate had continued to decline in September and in 2023 Q3 overall, in line with forecasts, going down to 8.83 percent from 9.43 percent in August and 10.25 percent in June. It was noted that the fall had been slower than in the previous two quarters, given that the further sharp decreases in the dynamics of food and energy prices during that period had been partly counterbalanced, in terms of impact, by the hike in fuel and medicine prices.
In contrast, the annual adjusted CORE2 inflation rate had seen a faster drop in Q3, falling visibly below the forecast to reach 11.3 percent in September, from 13.5 percent in June. That had owed mainly to a steeper disinflation in processed food prices, but also to the slower increases in the dynamics of non-food prices and services prices, Board members noted.
Following the analysis, it was agreed that the faster decline in the annual core inflation rate had been primarily driven by disinflationary base effects, downward adjustments in some commodity prices, especially agri-food items, as well as by the measure to temporarily cap the mark-ups on basic food products implemented in August, coupled with the influences of a plentiful crop domestically. Nevertheless, it also reflected a weaker pass-through of higher corporate costs, especially wage costs, into consumer prices, amid the slowdown in consumer demand, as well as a lower inflationary impact of imports, according to several Board members.
It was noted, in that context, that the annual dynamics of industrial producer prices for consumer goods on the domestic market had continued to decrease at a fast pace in Q3, while economic agents’ short-term inflation expectations had either posted a slower downward movement August through October or had seen small advances and financial analysts’ longer-term inflation expectations had remained relatively stable above the variation band of the target, after a visible drop in July. Moreover, the consumer purchasing power had continued to recover in the first two months of Q3, albeit at a visibly slower pace, reflecting the annual dynamics of the net real wage over that period, several Board members pointed out.
As for the cyclical position of the economy, Board members showed that the recently revised statistical data indicated a 1.7 percent rise in economic activity in 2023 Q2, after a 1.0 percent contraction in the previous three months, implying a large fluctuation in excess aggregate demand in H1 and its more modest narrowing in mid-2023 compared to forecasts.
Nonetheless, the deceleration in annual GDP dynamics to 1.0 percent in Q2 from 2.4 percent in Q1 was reconfirmed, on account of the sudden decline in the pace of household consumption growth. However, opposite influences had come from the strong acceleration in general government consumption growth compared to the same year-earlier period, as well as from the further fast annual dynamics of gross fixed capital formation, which had posted only a small decline, Board members remarked. At the same time, net exports had exerted a larger expansionary impact, given the further widening of the positive differential between the dynamics of exports of goods and services, in terms of volume, and those of imports, which had also triggered a new substantial decline in trade and current account deficits in 2023 Q2 versus 2022 Q2, several Board members pointed out.
Turning to the near-term outlook, Board members agreed that economic growth was likely to post a significant slowdown in the latter part of 2023, inter alia, compared to the previous forecasts, implying a much faster decline in excess aggregate demand in that period, as well as a more modest annual GDP growth rate than previously anticipated.
It was noted that, according to high-frequency indicators, gross fixed capital formation had been the main driver of economic growth in Q3 too, and that net exports could exert a new, even stronger, expansionary impact, given the further widening July through August of the positive differential between the annual dynamics of exports of goods and services and those of imports. Against that background, the trade deficit had seen its contraction in annual terms re-widen, while the current account deficit had posted only a slightly lower annual drop, given that the worsening in the primary income balance had been partly offset, in terms of impact, by the increase in the secondary income surplus during the first two months of Q3.
Looking at the labour market, Board members remarked the convergence of the signals sent by the latest data and surveys, showing that the monthly growth in the number of employees economy-wide had considerably lost momentum in July-August 2023, primarily on account of hiring in the private sector, while the ILO unemployment rate had decreased only marginally in Q3 overall, to 5.4 percent. In addition, in October, employment intentions over the very short horizon had declined at a mildly faster pace compared to the previous quarter’s average, while the labour shortage reported by companies had narrowed markedly, largely reversing the rise seen in Q3 on account of developments in industry and services.
It was also noted that the double-digit annual dynamics of the average gross nominal wage had continued to increase at a slower pace in the first two months of Q3, amid the faster deceleration reported in the private sector, while the annual growth rate of unit labour costs in industry had remained on the downward trend seen since May. Nevertheless, ULC dynamics were further particularly fast and a matter of concern from the perspective of inflation, Board members agreed.
At the same time, Board members highlighted the effects possibly exerted on the future evolution of wage costs in the private sector by the successive rises in the minimum wage and the removal of some tax breaks, as well as by potential additional hikes in the public sector alongside the persistence of the mismatch between labour demand and supply, at least in some segments, inter alia amid labour market structural deficiencies. It was deemed that firms’ elevated costs and tighter financial conditions, as well as the downward path of the inflation rate and the weaker domestic demand would act, however, in the opposite direction. Moreover, the potential additional increases in wage costs could be more visibly absorbed in profit margins, given the more cautious consumer behaviour, several members argued. Board members deemed that also relevant for the future evolution of labour market conditions were the implications of the fiscal measures implemented in order to continue budget consolidation, but also the higher resort by employers to workers from outside the EU and some firms’ tendency to enhance investment in equipment to compensate for the labour shortage.
Turning to financial conditions, Board members referred to the evolution of the main interbank money market rates, which had posted slight declines towards end-October, after the relative stability in the previous months. In turn, yields on government securities had steepened their downward correction recently, in line with developments in advanced economies and in the region. That had occurred amid investors seeing a potential additional increase in the Fed’s interest rate as less likely and the soothing of fears generated on the international financial market by escalating geopolitical tensions in the first part of October.
Against that background, but also given the still high relative attractiveness of investments in domestic currency, the EUR/RON exchange rate had quasi-stabilised at the higher readings reached in mid-September. Moreover, the leu had stopped its depreciation trend versus the US dollar seen in prior months, amid the halt in the latter’s strengthening trend on international financial markets.
Risks to the behaviour of the EUR/RON exchange rate could, however, heighten again, several Board members cautioned. They referred to the still considerable size of the external disequilibrium and the high uncertainties associated with fiscal consolidation, to the narrower domestic interest rate differential vis-à-vis developed countries and the prospective monetary policy stance of the Fed and the ECB, as well as to the current geopolitical tensions.
At the same time, it was noticed that the annual growth rate of credit to the private sector had lost momentum in September, to 4.5 percent from 5.5 percent in August. That had owed to a steeper decline in the dynamics of the foreign currency component, counterbalanced only to a small extent, in terms of impact, by the slight re-acceleration in the pace of increase of credit in lei. The share of leu-denominated loans in credit to the private sector had halted nevertheless its rise in September, coming in at 68.1 percent, amid the statistical effect of developments in the EUR/RON exchange rate.
As for future macroeconomic developments, Board members showed that the new assessments reconfirmed the outlook for a further fall in the annual inflation rate over the next two years, albeit on a higher-than-previously-envisaged path in 2024, yet slightly lower during the subsequent quarters. Specifically, the annual inflation rate would shrink to 7.5 percent in December 2023, similarly to the prior forecast, but would go up at the onset of next year, before declining gradually to 4.8 percent in December 2024 versus the previously-projected 4.4 percent. It would then accelerate its drop in 2025, falling to 3.3 percent, in the upper half of the variation band of the target, at the end of the projection horizon, i.e. in September.
Behind the step-up in the annual inflation rate at the beginning of 2024 stood the impact anticipated to be exerted by the increase and introduction of some indirect taxes and charges aimed at furthering budget consolidation. At the same time, the overall action of supply-side factors was expected to become disinflationary again afterwards, mainly under the influence of base effects and the downward adjustments of some commodity prices, especially of agri-food items, Board members highlighted on several occasions.
It was agreed, however, that the balance of risks to the anticipated inflation developments stemming from supply-side factors remained tilted to the upside, both in the short run and over the longer horizon, given the effects potentially generated by the changes in direct taxes and by the removal of some tax breaks, as well as the possible additional tax increases called for in the future by the budget consolidation process. Reference was also made to the uncertainties associated with the future evolution of oil prices, in light of the Middle East conflict.
Conversely, underlying inflationary pressures were expected to be somewhat stronger in 2023 H2 than in the previous forecast, softening visibly faster afterwards, before fading away entirely towards the end of the projection horizon, Board members concluded. They remarked the prospects for a relatively abrupt contraction of excess aggregate demand starting 2023 Q3, implying that the output gap would enter negative territory towards end-2024 – some quarters earlier than previously anticipated. Furthermore, the dynamics of unit labour costs would probably halt their upward path at end-2023 and then embark on a downward course, somewhat higher, however, than in the prior projection, some Board members pointed out.
Moreover, core inflation would continue to reflect the significant disinflationary influences, albeit on the wane or temporary, stemming from base effects and the downward adjustments of some commodity prices, as well as from improvements in global production and supply chains, alongside the three-month extension and the broadening of the scope of the mark-up caps on basic food products. By contrast, increasingly stronger influences were anticipated from the gradual decline in short-term inflation expectations and from the slower growth rate of import prices, whereas the changes in taxes and charges, as well as the rise in minimum wage, likely to affect firms’ costs, would probably put a brake on the decrease in core inflation dynamics, Board members underlined.
Under the circumstances, the annual adjusted CORE2 inflation rate would probably decline to 9.1 percent in December 2023, and then continue to fall gradually, yet at a faster tempo than headline inflation, reaching 5.2 percent in December 2024 and 3.4 percent at the end of the projection horizon, compared to the previously-anticipated 5.0 percent and 4.0 percent respectively.
As for the future cyclical position of the economy, Board members observed that, according to the new assessments, economic growth was expected to lose visibly more momentum in 2023 than previously anticipated, amid high costs, the shrinking external demand and the monetary policy stance. It was then seen rebounding only slightly in 2024, yet more steeply in 2025, given the budget consolidation, but also the stronger absorption and use of EU funds under the Next Generation EU instrument. The developments made it likely for the positive output gap to narrow much faster starting in 2023 Q3, implying the reversal of the cyclical position of the economy towards end-2024 and the subsequent relatively slow widening of the negative output gap.
It was noted that, after the abrupt loss of tempo in 2023, household consumption would probably become again the main determinant of GDP advance in 2024-2025, albeit with a smaller contribution than in previous years, amid a gradual recovery in the dynamics of households’ real disposable income, as well as high interest rates on household loans and deposits. By contrast, the growth rate of gross fixed capital formation was expected to stick to an upward path in 2023 and remain particularly swift from a historical perspective in 2024-2025, although at a lower level. That would be due to the absorption of a large volume of EU funds under the multiannual financial frameworks and the Next Generation EU programme, but also to the effects and uncertainties associated with the fiscal adjustment programme, Board members remarked.
Moreover, it was observed that net exports would exert, in turn, a notable expansionary impact in 2023, followed by a return to a negative contribution. Consequently, the current account deficit would probably witness a visibly more pronounced correction as a share of GDP in 2023 compared to previous forecasts, but would narrow only mildly over the following two years, remaining significantly above European standards across that horizon, Board members pointed out.
Sizeable uncertainties and risks further stemmed, nevertheless, from the future fiscal and income policy stance, Board members agreed. They referred to the recent actions aimed at containing budget expenditures in 2023 and the possible broadening over the next years of the package of corrective fiscal and budgetary measures, inter alia in light of the commitments made under the excessive deficit procedure and the conditionalities attached to other agreements signed with the EC. At the same time, reference was also made to the potential implications of the new legislation on pensions and wages in the public sector, as well as to possible further pay rises in the budgetary sector.
In that context, Board members underscored again the importance of absorbing and effectively using EU funds, especially those under the Next Generation EU programme, which were essential for carrying out the necessary structural reforms and energy transition, as well as for raising the growth potential and strengthening the resilience of Romania’s economy.
Furthermore, mention was made of the significant uncertainties and risks to the prospects for economic activity, implicitly the medium-term inflation developments, generated by the war in Ukraine and the Middle East conflict, as well as by the below-expectations economic performance in Europe, especially in Germany.
Board members were of the unanimous opinion that the reviewed context overall warranted keeping the monetary policy rate unchanged, with a view to bringing the annual inflation rate back in line with the 2.5 percent ±1 percentage point flat target on a lasting basis, inter alia by anchoring medium-term inflation expectations, in a manner conducive to achieving sustainable economic growth.
Moreover, Board members 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 keep the monetary policy rate at 7.00 percent. Furthermore, it decided to leave unchanged the lending (Lombard) facility rate at 8.00 percent and the deposit facility rate at 6.00 percent. In addition, 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.