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; Ágnes Nagy, 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 medium-term forecast of macroeconomic developments submitted by the specialised departments, as well as on other available domestic and external information.
In their addresses, Board members first examined the recent inflation developments. It was noted that the annual inflation rate had followed a steeper upward path in June to reach 0.85 percent from 0.64 percent in May, remaining, however, among the lowest in Europe. Board members remarked that the upward movement in the annual inflation rate in Q2 had been faster than anticipated and that, in the absence of all changes in indirect taxes, excises and non-tax fees and charges, it would have climbed to 1.9 percent in June 2017, i.e. inside the variation band of the flat target. The rise had been mainly induced by core inflation and administered price inflation, to which added the dynamics of VFE prices and tobacco product prices. Those influences more than offset the impact exerted by the decline in fuel prices amid the unexpected drop in oil prices and the relative strengthening of the leu against the US dollar.
Board members observed that the annual adjusted CORE2 inflation had exceeded the forecasted level even more visibly, given its continued advance in Q2 to 1.42 percent in June, whereas the medium-term forecast had anticipated its quasi-stagnation around the 1.04 percent level seen in March; moreover, in the absence of the standard VAT rate cut, it would have risen to 1.6 percent, a high since September 2013. It was noted that core inflation had increasingly reflected inflationary pressures from fundamentals, particularly those stemming from the cyclical position of the economy and unit labour costs, but that they had recently continued to be mitigated by some persistent or one-off disinflationary influences; apart from heightened competition in retail trade and other sectors holding relevant shares in the CPI basket, the latter had been generated by the leu exchange rate developments and the indirect effects of the drop in oil prices, as well as by the slight slowdown in inflation in the euro area and the EU, alongside the presumed increase in the role of imported inflation. Domestic pressures were deemed to have become even stronger on producer prices of consumer goods, especially on those of food items.
Turning to economic activity, Board members showed that the significant advance in its dynamics in Q1 – leading to a markedly larger expansion of the positive output gap – had been entirely ascribable to domestic demand, whose faster growth had owed to the contribution of both its major components. Net exports had made a considerably lower positive contribution to GDP growth, amid the narrowing of the favourable spread between the growth rate of exports of goods and services and that of imports thereof. Given the swift expansion in domestic demand, the current account deficit had continued to deepen, a singular situation in the region, but without being threatening yet.
Board members noted that the latest statistical data pointed to a slight deceleration in economic growth in Q2, which implied however – with its rate remaining above the previously-forecasted levels – a relatively wider opening of the positive output gap over the short-time horizon. The same data indicated private consumption as the engine of the robust economic growth in 2017 Q2, as well as a probably negative contribution of gross fixed capital formation, in view of the new fall in the volume of construction owed, inter alia, to the renewed decline in civil engineering works. The contribution of net exports to GDP dynamics could turn negative again in 2017 Q2, amid the wider deficit on trade in goods and services versus April-May 2016, whose impact on the dynamics of the current account deficit had been counterbalanced so far by the change in primary income balance.
Looking at labour market developments, Board members pointed out that the number of employees economy-wide had continued to grow April through May, albeit at a slightly slower pace, and the ILO unemployment rate had reached again the 5.3 percent historical low in June, after having edged up marginally in the previous month. Board members viewed that those developments, combined with the broadly positive short-term outlook for employment and the enhanced difficulties in recruiting skilled labour, revealed by relevant surveys, hinted at further labour market tightening. In that context, Board members pointed out the further double-digit annual dynamics, in the first two months of Q2, of both the average gross wage earnings and the unit wage costs in industry on the consumer goods segment, despite a moderate slowdown across the sector.
Board members deemed that the real monetary conditions had been highly accommodative in June-July, given, inter alia, the recent and anticipated speed-up in inflation, as well as the fall to a new historical low in the interest rates on households’ new time deposits. Mention was also made of the advance in the dynamics of credit to the private sector in June, alongside the widening to 60.2 percent of the share of its domestic currency component. Some Board members underlined, in light of the monetary policy transmission, the persistence of the negative differential between the dynamics of credit and the pace of economic growth, implying a delay in restoring financial intermediation; apart from the still large volume of non-performing loan sales, among the possible causes that were referred to were households’ relatively low indebtedness capacity and the undercapitalisation of many firms. Some Board members noted, in that context, that behind the above-potential growth of the domestic economy stood primarily the pro-cyclicality of fiscal and income policies and the improvement in sentiment on the domestic market.
Board members discussed the new medium-term forecast. It was shown that the forecast reconfirmed the outlook for the annual inflation rate to gain significant momentum throughout the projection interval, even more pronounced than previously foreseen, given that the projected path of the annual inflation rate had been revised upwards over the entire forecast period, particularly in the short term. Specifically, the annual inflation rate was expected to re-enter the variation band of the flat target as early as 2017 Q3 and stand at 1.9 percent at year-end, instead of the previously forecasted 1.6 percent; recalculated at constant tax rates, annual CPI inflation was seen picking up to 2.9 percent at end-2017. It was noted that, against that background, the annual inflation rate would probably rise significantly above the central target as early as the first months of 2018, amid sizeable base effects at the beginning of next year, associated with the previous cuts in indirect taxes and fees. Moreover, it was then seen on a more slowly rising path, to reach 3.2 percent in December 2018 and 3.5 percent – the upper bound of the variation band of target – at the projection horizon, compared to 3.1 percent and 3.4 percent respectively in the prior forecast.
Board members pointed out the solid contribution of supply-side factors to the upward profile of the forecasted path of the annual inflation rate and to its upward shift. That owed mainly to the already mentioned base effects, as well as to the anticipated dynamics of exogenous CPI components, influenced inter alia by their recent behaviour and by the expected developments in energy and agri-food commodity prices. Mention was made of the upward adjustment, over the short time horizon, in the anticipated growth rates of VFE prices, administered prices – in particular of electricity – and tobacco prices, only partly offset by the downward revision of the projected fuel prices. At the same time, Board members referred to the uncertainties surrounding the outlook for those prices, oil price included, assessing the balance of ensuing risks to be in relative equilibrium, except for electricity. Upside risks also stemmed from the potential future setup of the indirect taxation system, given the announced introduction of a surcharge on unhealthy foods and beverages.
In their analysis, Board members repeatedly underlined, however, that the prospective step-up in inflation and the upward revision of the inflation forecast were primarily ascribable to fundamentals, which impacted core inflation in particular. They noted that the annual adjusted CORE2 inflation rate was expected to witness a steeper uptrend in the following quarters and stand at higher-than-previously anticipated values, steadily above the headline inflation rate, especially towards the end of the forecast interval. Looking beyond the base effects in 2018 Q1, that outlook reflected relatively stronger inflationary pressures anticipated to be generated by the cyclical position of the economy, unit wage costs, and by the uptrend in short-term inflation expectations. Less intense pressure was expected to be exerted by prices of imports – also against the backdrop of the likely higher import volume –, amid the downward revision of their projected path.
Board members noticed that the widening of the forecasted positive output gap was markedly larger throughout the projection period, underpinned by faster-than-expected economic growth in 2017 Q1, as well as by the significant upward revision of the prospective GDP dynamics for 2017 and 2018. Economic growth was expected to record in 2017 a renewed significant pick-up against the previous year and to slow down in 2018, although further outpacing potential GDP dynamics. It was remarked that the main assumption underlying the outlook was the relative strengthening of the pro-cyclical stance of the fiscal and income policies; furthermore, it implied the preservation of a considerably accommodative nature of real monetary conditions, as well as relatively sturdier economic growth in the euro area/EU and globally.
According to the Board members’ analysis, household consumption was seen to likely remain the almost sole driver of economic growth in the period from 2017 to 2018, while the contribution of gross fixed capital formation was anticipated to be even more modest than previously expected. Some members voiced their concern about that growth pattern, given its adverse implications on potential GDP. It was pointed out that faster dynamics of investment were conditional on EU funds absorption, public investment, and corporate profits, the latter being affected inter alia by commodity- and wage-related costs; equally important were deemed to be the predictability of the legislative framework, the infrastructure quality, and the availability of skilled staff, and hence the need was highlighted for comprehensive structural reforms in those areas.
In that context, some Board members considered there were strong arguments in favour of a monetary policy response from the central bank. Reference was also made to the risk of a potentially higher degree of pro-cyclicality of the fiscal and income policies, coupled with a more unfavourable composition of public spending, conducive to fostering primarily consumer demand and widening the positive output gap and the current account deficit. Similar implications, also via weakening competitiveness, might stem from companies’ potentially larger increase in wage costs – amid the demonstration effect and labour market tightening – and their no longer having room for a further narrowing of profit margins.
Board members agreed, however, that the outlook for the fiscal and income policy stance was difficult to anticipate at the current juncture, given the heightened uncertainty surrounding the actual manner of implementing the unified wage law, as well as the set of measures that would probably accompany it, designed to alleviate its expansionary effects; to those added the uncertainty about the possible adoption of corrective fiscal measures in the context of the envisaged budget revision, important also in terms of their potential effects on the investment and consumption behaviour, therefore warranting close scrutiny. Furthermore, it was remarked that not all elements of the short- and medium-term fiscal strategy were available for the time being. Moreover, it was pointed out that the markedly lower-than-expected rate of absorption of EU structural and investment funds under the 2014-2020 financial framework would likely continue, at least in the near future.
Board members underscored the two-way risks induced by the external environment to the domestic inflation outlook amid the relative balancing of risks to economic growth and inflation in the euro area and globally, insisting on the downside risks stemming from the uncertainties about Brexit and from the economic policies of the US, as well as from the globalisation of production chains worldwide and from the behaviour of large chain stores. Also relevant were deemed to be the uncertainties and risks originating in the major central banks’ monetary policy stances and the view was therefore expressed that the leu’s exchange rate dynamics and their impact on the balance of payments should not be underestimated. The conduct of other central banks in the region was also examined, including from the perspective of the signal which could be conveyed by the ECB at the following monetary policy meeting. Under the circumstances, several Board members underlined the need for a balanced macroeconomic policy mix with a view to safeguarding macroeconomic stability, while reiterating that monetary policy could not counterbalance the heightened pro-cyclicality of other economic policies without generating adverse effects.
In light of the analyses, Board members judged it appropriate to leave the monetary policy stance unchanged, with a view to ensuring price stability over the medium term in a manner conducive to achieving sustainable economic growth. Specifically, the NBR Board unanimously decided to keep the monetary policy rate at 1.75 percent per annum; in addition, the Board unanimously decided to maintain at ±1.50 percentage points the symmetrical corridor of interest rates on the NBR’s standing facilities around the policy rate, to further pursue adequate liquidity management in the banking system, as well as to leave unchanged the minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions.