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 current and future macroeconomic, financial and monetary 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. They observed that the annual inflation rate had continued to leap during the first two months of 2017 Q4, going up from 1.77 percent in September to 2.63 percent in October and to 3.23 percent in November, close to the upper bound of the variation band of the flat target and significantly above the forecast. The advance in the prices of consumer goods and services had been almost across the board, with all major CPI components contributing to the step-up in inflation. The main contribution had been made by supply-side factors, administered prices in particular – given the increase in the electricity price – as well as fuel prices, in the context of the hike in the excise duty on motor fuels and of higher oil prices; influences had also come from the developments in VFE prices and tobacco product prices.
Board members remarked that the adjusted CORE2 inflation had also made an important contribution, given its faster-than-forecasted annual rate of increase to 2.3 percent in November from 1.82 percent in September. The advance had mainly stemmed from processed food prices, reflecting, inter alia, the international price movements, and, to a much lower extent, from services prices, which are more sensitive to exchange rate fluctuations. It was deemed that the evolution of core inflation was in line with the strengthening trend of the cyclical position of the economy and the consolidation of the fast dynamics of unit labour costs, indicating a more conspicuous build-up of inflationary pressures from fundamentals, on the demand and cost sides. It was shown that additional inflationary influences had stemmed during that period from the relative weakening of the leu versus the major currencies, as well as from the likely indirect effects generated by the higher prices of oil on international markets and of some utilities, also hinted at by the upward adjustment of short-term inflation expectations.
As for the cyclical position of the economy, Board members remarked that, in Q3, economic growth had witnessed the fourth successive faster-than-expected acceleration, which had also been the most significant one; the annual growth rate of GDP had climbed to 8.8 percent, from 6.1 percent in Q2, given that, contrary to forecasts, its quarterly rate had followed a more pronounced upward trend to a ten-year high. The main driver of economic growth had further been household consumption whose annual dynamics had risen to a two-digit level, similar to the levels seen prior to the global crisis, while gross fixed capital for¬mation had also made a significant positive contribution, for the first time in six quarters. Conversely, the negative contribution of net exports to GDP growth had doubled amid a stronger deceleration in the growth of exports than in that of imports; against that background, the negative balance on trade in goods and services had almost trebled versus the same year-earlier period to reach a 19-quarter high.
Turning to GDP formation, it was shown that agriculture had played an important part, its contribution (the largest in four years) standing higher than that of industry and being exceeded only by that of services.
Board members deemed that the Q3 developments pointed to a new increase, significantly above expectations, in excess aggregate demand, probably moderated somewhat by the temporary pick-up in potential GDP in that interval, under the impact of the positive supply-side shock from bumper crops.
Against that backdrop, Board members underlined that in October the number of employees in the economy had reached a record high for the sixth consecutive month, while its growth rate had further followed a downward trend, which indicated a contained room for employment to expand and implicitly higher difficulties encountered by companies in recruiting skilled labour. By contrast, the unemployment rate had remained flat at 4.9 percent in August-October and the job vacancy rate had seen a decline in Q3. It was considered that the likely halt in the labour market tightening trend suggested by those developments was, however, of a temporary nature, given that surveys showed relatively more optimistic employment prospects for 2018 Q1. In that context, reference was made to the two-digit levels (particularly high from a historical perspective and compared with those recorded in 2016) further posted in Q3 by the annual dynamics of the average gross nominal wage and of the total hourly labour costs. In October, the annual growth rate of unit wage costs in industry had, however, reverted to the downward trend it had entered in 2016 Q4, after a temporary rise in Q3 as a result of a slower advance in labour productivity. Board members deemed that monetary conditions had become slightly less accommodative in 2017 Q4. Mention was made of the significant pick-up in the relevant money market rates – to the highest levels in the region and the EU –, as well as of the relatively slow pass-through of this movement to interest rates on new loans and new time deposits in October and November, especially on the households segment. Reference was also made to the real appreciation of the leu against the major currencies in Q4, in spite of its nominal depreciation tendency versus the euro that had further been manifest during most of the interval. In the context of a persistent net liquidity deficit on the money market, as a result of the higher volatility of the autonomous factors, the NBR had continued to provide liquidity via repo operations with full allotment in November-December. However, those operations had been stopped towards the year-end, given the re-emergence of a substantial net reserve surplus in the banking system, following the liquidity injections triggered by the wide easing of budget execution.
Board members also noted that the nominal annual growth rate of credit to the private sector had slowed only marginally in the first two months of 2017 Q4. The robust increase had further been driven quasi-exclusively by the domestic currency component, whose share in total private sector credit had widened to 61.8 percent, primarily on account of loans to households, in particular loans for house purchase. The slowdown in the annual dynamics of credit to the private sector was somewhat more pronounced in real terms, given the steepening of the uptrend in the annual inflation rate.
Turning to future developments in the main macroeconomic indicators, Board members remarked that the new data and assessments reconfirmed the outlook for the annual inflation rate to pick up in the months ahead, under the impact of rising pressures from supply-side factors and from fundamentals, overlapping in the early months of 2018 the inflationary base effects associated with the indirect tax cuts and removals and with the decline in administered prices. It was observed that the anticipated values of the annual inflation rate over the short time horizon were significantly higher than those in the medium-term forecast published in the November 2017 Inflation Report, standing considerably above the upper bound of the variation band of the flat target, but also that the upward revision was almost entirely attributable to the action of supply-side factors; the main additional influences were expected to stem from the evolution of fuel prices, amid the relative rise in oil prices, from recent increases in prices for VFE and for tobacco products, as well as from the relatively higher dynamics of administered prices.
Against this background, some Board members referred to the transitory nature of the inflation bout that would probably be manifest in the first quarters of 2018, given the foreseeable fadeout towards the end of this year of the effects exerted by many of the supply-side inflationary shocks triggering the bout, and reiterated that the medium-term forecast saw the annual inflation rate at 3.2 percent in December 2018 and at 3.1 percent in September 2019. At the same time, however, the concern was voiced about the risk that, owing to mounting pressures from excess aggregate demand, the anticipated heightening of the impact of supply-side shocks – pushing and keeping the annual inflation rate well above the upper bound of the variation band of the flat target for a few quarters – might de-anchor inflation expectations over the longer time horizon. In this context, reference was also made to the relationship between domestic prices and exchange rate dynamics. In the short run, a major source of uncertainty and upside risks to the inflation outlook was deemed to be the evolution of fuel prices and other utility prices, amid high volatility of international oil prices.
Board members then discussed the possible implications of the new assessments on economic growth over the short time horizon, which indicated for 2017 Q4 and 2018 Q1 a markedly faster-than-previously forecasted advance in annual terms, while at the same time reconfirming the prospects for the latter to re-enter a decelerating trend, even slightly steeper than that anticipated in November 2017. It was noted that those forecasts corresponded to a very slight downward revision of the quarterly GDP dynamics anticipated for the two aforementioned quarters which, associated with the acceleration way above expectations in the economic growth in Q3, rendered highly likely a larger widening of the positive output gap and hence strengthening of its inflationary pressures during that period compared with the medium-term forecast.
In addition, according to high-frequency indicators, private consumption would likely continue to be the main driver of robust economic growth in 2017 Q4 as well. It could be followed by a modest contribution from gross fixed capital formation, potentially fuelled by the considerable rise in public spending towards year-end, albeit amid the highly likely compliance of the 2017 fiscal deficit with the scheduled parameters. The contribution of net exports was, however, expected to turn more negative, given the sizeable increase in October in the negative balance on trade, making a decisive contribution to the strong acceleration in the widening trend of the current account deficit versus the same year-earlier period.
Following the analysis, Board members found that the current context called for further adjustment of the monetary policy stance via an increase in the monetary policy rate by 0.25 percentage points, to 2.00 percent. Additional arguments for this move were the risk of stronger-than-expected pro-cyclicality of fiscal and income policies in 2018 or that of a chronic worsening of budget expenditure composition, through a potential reduction in public investment towards critical values in favour of supporting consumption, conducive to impairing the Romanian economy’s growth potential and to a larger positive output gap over the medium term, as well as to a wider current account deficit. In this context, Board members repeatedly underlined the importance of a balanced macroeconomic policy mix, also deemed essential from the standpoint of avoiding the overburdening of monetary policy and preventing undesired effects across the economy; some members mentioned among such effects a potential re-euroisation process that might seriously affect monetary transmission as well.
Discussions also touched upon the upside risks to the inflation outlook stemming from a possibly higher increase in corporate costs, along with tighter profit margins, due mostly to the new fiscal measures and labour market tightening. Some Board members also referred to the potentially faster-than-expected growth of the euro area and global economies over the short time horizon, inter alia amid the persistence of low inflation, which would underpin the prospects for a slow normalisation of the monetary policy stances of the major central banks.
At the same time, however, mention was also made of the uncertainties and opposite risks surrounding the economic growth outlook in the event that some employers did not fully offset the shift in social security contributions onto employees, as well as those stemming from the possibility of further corrective fiscal measures during 2018, with a view to ensuring compliance of the fiscal deficit with the 3 percent-of-GDP reference value. Board members also pointed out the risk of a protracted anaemic nature of EU funds absorption under the 2014-2020 financial framework, as well as that of a more visible decline in households’ real disposable income dynamics under the impact of relatively stronger direct and indirect inflationary effects exerted by supply-side shocks. Looking at the external environment, the possibly weaker-than-anticipated inflation performance in the euro area and in other developed countries was highlighted, despite a more robust economic expansion.
Under the circumstances, the NBR Board unanimously decided to increase the monetary policy rate to 2.00 percent from 1.75 percent, as well as to raise the deposit facility rate to 1.00 percent from 0.75 percent and the lending (Lombard) facility rate to 3.00 percent from 2.75 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.