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 forecast of medium-term macroeconomic developments submitted by the specialised departments, as well as on other available domestic and external information.
Board members first showed that in March the annual inflation rate had continued to rise above the upper bound of the variation band of the flat target to reach 4.95 percent, as forecasted, from 4.72 percent in February. It was noted that, in line with expectations, the annual inflation rate had seen a more pronounced increase in Q1 than in September-December 2017, primarily attributed to supply-side factors. Apart from the fading out of the temporary effects associated with cutting/scrapping of indirect taxes and non-tax fees and charges implemented in the same year-earlier period, behind this increase had stood adjustments in administered prices, namely the prices of electricity, natural gas and heating, as well as costlier fuels amid the advance – albeit more moderate than expected – in oil prices.
At the same time, Board members noticed an increased contribution made also by core inflation, which had continued to accelerate in Q1, exceeding expectations once again, as the annual adjusted CORE2 inflation rate had gone up from 2.5 percent in December 2017 to 3.0 percent in March 2018. The evolution of the adjusted CORE2 inflation was deemed to reflect stronger demand-pull and cost-push inflationary pressures, in the context of the economy’s advanced cyclical position and tight labour market conditions. The arguments supporting that view referred, inter alia, to the broad-based increases in the prices included in that indicator, as well as to the stronger upward movement on the services segment, only partly ascribable to the slight depreciation of the leu against the euro. Mention was also made of possible stronger indirect effects of higher prices of oil and some utilities, as also suggested by a further upward adjustment of short-term inflation expectations.
Turning to the cyclical position of the economy, Board members remarked that the revised statistical data indicated only a slightly more pronounced deceleration in economic growth in 2017 Q4 than previously estimated, its annual dynamics remaining robust at 6.7 percent. Moreover, its general composition by driver posted minor adjustments, as the prevailing, albeit lower, contribution of household consumption had been slightly revised downwards, the same as the rising positive contribution of gross fixed capital formation, concurrently with a higher negative value being reconfirmed for net exports. The latter reflected the widening negative differential between the annual growth rate of exports and that of imports, contributing to a faster deepening of the current account deficit, which in 2017 as a whole had come in at 3.4 percent of GDP.
At the same time, it was shown that the slowdown in economic expansion would see a relative moderation in 2018 H1 compared to 2017 Q4, given the anticipation of a notable renewed step-up in its quarterly dynamics in January-March, followed only by a marginal slowing in Q2. Board members observed that such a context made it likely for the slow upward trend of excess aggregate demand to persist into the first part of the current year and that the sizeable downward revision of its magnitude estimated for 2017 and beyond owed to the large revision by the NIS of the historical data series on GDP. According to high-frequency data, in 2018 Q1 private consumption was deemed to have probably remained the main driver of the still robust economic growth, while also being the main culprit for its slowdown, with gross fixed capital formation possibly making an increasing positive contribution to GDP dynamics, under the impact of the revival in non-residential buildings and engineering construction works. By contrast, the negative contribution of net exports would possibly remain unchanged or even grow larger, as Board members expressed concern about the further rising annual dynamics of imports of goods and services and the faster advance in the current account deficit in the first months of the current year against the same year-earlier period. The decline, in year-on-year terms, in the volume of foreign direct investment was also observed.
Board members underlined the high degree of labour market tightness anticipated to persist, in light of, inter alia, the latest data and survey outcomes, which showed, however, a slight moderation of near-term employment expectations. It was remarked that, in the first months of 2018, the number of employees in the economy had continued to reach new peaks, while posting a slower advance in annual terms – that time owing also to the contribution of the public sector – and that the ILO unemployment rate had touched a new historical low of 4.5 percent in March. It was considered that pressures on wages could be higher than suggested by those data, given that the severe shortage of highly skilled workforce and the ongoing emigration were likely not to favour new recruiting, while also enhancing competition for the existing personnel. In that context, it was noted that the annual growth rate of average gross nominal wage earnings economy-wide had picked up again in February, the indicator adjusted for the effect of transferring the social security contributions thus returning to a two-digit level, solely on account of private sector developments. It was observed that, amid the marked pick-up over the last years, the ratio between the minimum wage economy-wide and the average gross wage earnings had gone beyond the prevailing median across the EU, exceeding 45 percent in 2017. The annual dynamics of unit wage costs in industry had also seen a renewed step-up in February, especially in manufacturing, given, inter alia, weaker labour productivity growth.
Board members deemed that monetary conditions had continued to become less accommodative in April. Reference was made to the relevant interbank money market rates increasing and remaining above the policy rate subsequent to the NBR’s launch of time deposit-taking operations with full allotment, as well as to the relative stability of the leu exchange rate. The widening trend in the spread between the interest rates on new loans and those on new time deposits in Q1 was also emphasised, but a reversal was anticipated once with the consolidation of the effects caused by the NBR’s tighter control over money market liquidity, entailing also a stronger competition among banks for raising liquid funds, possibly fostered by the Ministry of Public Finance’s initiative to issue government securities for households. In this light, the view held was that the pass-through to the market of the effects arising from the previous months’ monetary policy measures was still ongoing.
Board members noted that the advance, in annual terms, in credit to the private sector had remained steady at 6.1 percent in March, amid a slight step-up in the dynamics of loans to households, the impact of which had been offset by the slowdown in the growth rate of loans to non-financial corporations. The expansion of credit had continued to arise only from loans in lei, whose share in total had climbed to 63.6 percent.
When discussing future developments, Board members remarked that the new medium-term forecast broadly reconfirmed the coordinates of the projection included in the February 2018 Inflation Report, the projected path of the annual inflation rate being only slightly revised upwards in the short run and marginally downwards over the longer time horizon. Specifically, after a foreseeable renewed rise in April, the annual inflation rate was expected to stay for several months around that high level, before returning at end-2018 in the vicinity of the upper bound of the variation band of the target, reaching 3.6 percent, and afterwards declining but also levelling off in the upper half of the band, to stand at 3 percent at the end of the forecast horizon, marginally below the previously-projected level of 3.1 percent.
In their addresses, Board members showed that the sizeable fluctuation in the likely evolution of inflation in 2018 and the slight upward adjustment of its pattern over the short term were attributable to the action of supply-side factors, consisting in large hikes recorded recently by all exogenous CPI components and in the associated base effects that would be manifest starting with 2018 Q4. The main influences came from the recent months’ significant increases in electricity and natural gas prices, as well as from the faster pick-up in fuel prices, amid costlier oil and the reintroduction of the special excise duty on motor fuels; similar effects also stemmed from the rise in tobacco product prices, primarily due to the increase in the specific excise duty, and to a lower extent from higher VFE prices.
Some Board members underlined that the likely steeper and relatively persistent climb of the annual inflation rate significantly above the upper bound of the variation band of the target implied the risk of de-anchoring inflation expectations over the medium term and hence generating considerable second-round effects, especially amid growing pressures from fundamentals, implicitly compounding the efforts and costs of bringing inflation back under control. At the current juncture, the risk was heightened by the potentially faster-than-expected increase in some administered prices, but particularly in international oil prices, the relationship between domestic prices and the leu exchange rate dynamics being considered relevant as well. Against this background, members repeatedly underlined the need for anchoring medium-term expectations and calming shorter-term ones, also from the perspective of central bank credibility.
Moreover, it was pointed out that core inflation was expected to pick up further throughout the forecast horizon, although at a slower pace than in the previous projection, the annual adjusted CORE2 inflation rate being anticipated to climb to 3.4 percent in December 2019 and then to the upper bound of the variation band of the target in March 2020; thus, the core component of inflation was the sole culprit for the forecasted annual inflation rate staying in the upper half of the band during 2019 and afterwards.
It was noted that the relatively lower forecasted path of the annual adjusted CORE2 inflation rate was almost fully ascribable to the downward reassessment, both in retrospect and in the period ahead, of the estimated positive output gap, given the sizeable revision of the historical data series on economic growth. It was observed that, although relatively diminished versus the previous forecast, inflationary pressures triggered by the cyclical position of the economy were expected to strengthen further in the first part of this year and then remain almost unchanged until towards mid-2019; furthermore, their abatement over the longer time horizon would probably be slower, considering that the positive output gap was expected to re-embark on a narrowing trend not earlier than towards mid-2019, namely with a delay of almost two quarters compared with the previous forecast, while its subsequent decrease was seen unfolding at a markedly slower pace. In addition, slightly stronger inflationary pressures – even than in the February projection – were anticipated to stem, primarily in the first part of the forecast horizon, from the steeper uptrend in short-term inflation expectations, whereas import price dynamics were seen exerting somewhat milder pressures initially, yet rising progressively.
Assessing the new anticipated pattern of excess aggregate demand, Board members remarked that the updated forecasts reconfirmed the previously-projected economic growth momentum for the current year, but revised that for 2019 considerably upwards. Therefore, economic expansion was anticipated to witness a relatively pronounced slowdown in 2018, followed however by a significantly slower deceleration in 2019, the forecasted pace of growth thus remaining above potential in 2018 and falling only slightly below potential next year. It was shown that the outlook implied a relative alleviation, also in relation to the previous forecast, of the expansionary nature of the fiscal policy in 2018 – which was then seen becoming quasi-neutral in 2019 – , as well as a notably moderating increase in households’ real disposable income over the projection horizon. The outlook also assumed monetary conditions would become markedly less accommodative during this year and turn marginally restrictive towards end-2019, the hypotheses including, however, a relative improvement in EU funds absorption, as well as brighter prospects for economic growth in the euro area/EU and globally.
Board members highlighted the role as engine of economic growth that private consumption would probably continue to play, even though on the wane, as well as the need for an increase in the contribution of gross fixed capital formation, anticipated to be modest this year as well, albeit on a slight upward path. From this perspective, members reiterated the importance of public investment and of EU funds, but also of local and non-resident investors’ confidence, depending on the economic fundamentals, including on the quality of the business environment and of the governance and legislative frameworks. At the same time, it was observed that net exports were expected to widen their negative contribution to GDP dynamics and concerns were voiced about the likely further uptrend in the current account deficit as a share of GDP, pointing to the need to avoid/minimise competitiveness losses of the economy.
Following the analysis, Board members considered that the current context called for further adjustment of the monetary policy stance via an increase in the monetary policy rate by another 0.25 percentage points. The approach was warranted, inter alia, by the upside risks to the inflation outlook induced by the high degree of labour market tightness and by this market’s structural weaknesses, with a potentially stronger-than-expected impact on wage dynamics and hence on firms’ costs. Mention was also made of the characteristics of budget execution in the first quarter of the year, as well as of the likelihood of relatively sturdier growth of euro area and global economies in 2018, in the context of synchronised above-trend expansion in developed and emerging economies, fostered, among others, by the persistence of loose financial conditions and by the fiscal stimulus implemented by the US Administration. Some Board members underlined that hiking the policy rate was also necessary in order to safeguard the central bank’s credibility in the current context.
Board members deemed those risks as prevailing in the current context. They also pointed out, however, the uncertainties surrounding the carrying out of public investment and of the EU funds absorption programme. Reference was also made to the trend in household and corporate confidence, as well as to the potentially stronger impact exerted on households’ real disposable income by hikes in fuel prices and some utility prices.
Looking at the external environment, discussions touched upon the persistence of low inflation in the euro area and other EU countries, as well as upon the monetary policy stances of the major central banks, particular relevance being attached to the approach of the ECB and that of central banks in the region. Against that background, Board members reiterated the importance of a balanced macroeconomic policy mix, deemed essential also from the standpoint of avoiding the overburdening of monetary policy and preventing undesired effects in the economy. Mention was also made of the risks to the economic growth outlook in the euro area and globally stemming from the possible escalation of trade protectionism and of geopolitical tensions.
Under the circumstances, the NBR Board unanimously decided to increase the monetary policy rate to 2.50 percent from 2.25 percent, as well as to raise the deposit facility rate to 1.50 percent from 1.25 percent and the lending (Lombard) facility rate to 3.50 percent from 3.25 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.