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 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 consumer prices, Board members showed that, in December 2021, the annual inflation rate had climbed above expectations, to 8.19 percent from 7.80 percent in November, rising even higher above the variation band of the target and adding 6.13 percentage points from the end of 2020. 80 percent of the advance seen in 2021 had come, however, from the increases in natural gas, electricity and fuel prices, while half of the contribution of only 15 percent made by core inflation had been attributable to processed food, Board members remarked, underlining the much more modest rise in the annual adjusted CORE2 inflation rate to 4.7 percent in December 2021, from 3.3 percent in December 2020. It was emphasised yet again that inflation developments in Romania had been driven by global supply-side shocks, which had triggered a steep upward movement of inflation worldwide in 2021, way above central banks’ inflation targets, including in numerous European countries. On the domestic front, their impact had been compounded by the liberalisation of the electricity market for household consumers at the beginning of 2021, several Board members reiterated.
It was noted that the new pick-up in the annual inflation rate in 2021 Q4 – from 6.29 percent in September – had been significant, but more modest than in 2021 Q3, given the capping and compensation of energy prices for households starting with November. The rise had further been primarily driven by exogenous CPI components, particularly additional hikes in natural gas and electricity prices, as well as in fuel prices – mainly on account of the non-petrol-diesel subgroup.
At the same time, the annual adjusted CORE2 inflation rate had followed a slightly higher upward path during that period, also compared with the forecasts, adding 1.1 percentage points, but mainly following the new across-the-board increases in the processed food segment amid the hikes in commodity prices and higher energy and transport costs. The contributions made by the non-food and services subcomponents had been yet again far lower, even amid a relatively large range of goods and services having further recorded small price increases, most likely reflecting rising production costs on the external and domestic fronts, inter alia in the context of the fourth pandemic wave.
Following the analysis, Board members agreed that the step-up in annual core inflation rate was also ascribable to adverse supply-side shocks, particularly to external ones, whose direct and indirect effects had been compounded by increasingly higher short-term inflation expectations and the large share of imported goods in the CPI basket. During the discussions, members referred to the sharp rises in industrial producer prices at European level and domestically over the recent months – under the influence of higher costs of energy, transport and other commodities, including agri-food items, as well as due to persistent bottlenecks in global value chains –, likely to pass through, with a time lag, but also depending on demand, into the prices of almost all consumer goods and services, inter alia via imports. Furthermore, the recent significant upward adjustments in economic agents’ short-term inflation expectations were pointed out, but also the much slower increase in longer-term inflation expectations, as well as the erosion trend of the purchasing power of consumers, reflected in the dynamics of the average real net wage entering and falling deeper into negative territory over the recent months.
As for the cyclical position of the economy, Board members remarked that the new preliminary version of statistical data reconfirmed the slowdown in economic growth in 2021 Q3, to 0.4 percent from 1.5 percent in Q2, contrary to expectations, which implied the contraction of excess aggregate demand in that period to a much lower value than forecasted in November 2021, also due to the notable downward revision of statistical data on economic growth in 2021 H1.
In addition, the significantly faster-than-expected drop in the annual GDP dynamics in 2021 Q3 – to 7.4 percent from 13.9 percent in Q2 – was reconfirmed, alongside the main drivers of the still high growth from a historical perspective, some Board members noted. Specifically, the main contribution had come from household consumption, followed by an unusually large one from the change in inventories, while gross fixed capital formation had seen a small decline in annual terms for the first time in 11 quarters, somewhat more pronounced than in the previous data series. Moreover, net exports had further made a negative contribution to annual GDP dynamics, yet significantly narrower versus the previous quarter and marginally smaller than previously estimated, even amid a somewhat faster decline in the annual change in exports of goods and services than that in imports thereof. However, trade deficit had deepened in annual terms at a much stronger pace, given the relatively more unfavourable developments in the prices of imports.
Turning to near-term prospects, Board members shared the view that a new slowdown in economic growth was likely in 2021 Q4, followed by a minor reacceleration in 2022 Q1, in the context of the successive pandemic waves, the energy crisis and bottlenecks in production and supply chains, implying during that period, overall, a markedly faster deceleration of GDP dynamics than anticipated in November 2021, especially in annual terms. The evolution made it likely for excess aggregate demand to only see a marginal rise during that period and thus stand significantly below the prior forecast.
It was noted that, according to the latest high-frequency indicators, the fall in annual GDP dynamics in 2021 Q4 had probably been driven mainly by private consumption and, to a lower extent, by gross fixed capital formation, the declining annual changes of which had continued, however, to reflect significant base effects too. Nevertheless, the negative contribution of net exports to GDP dynamics was likely to have shrunk again, considering that the persistence into October-November of the unfavourable differential between the decelerating growth rate of exports of goods and services and that of imports thereof had been entirely attributed to adverse developments in external prices. Against that background, the trade deficit had further recorded a faster increase in annual terms, while the current account deficit had resumed a considerable step-up in its annual dynamics, also following the worsening of the secondary income balance, and hence widened by 57 percent in January-November 2021 overall against the cumulative deficit in the same year-earlier period. The developments were viewed as particularly worrisome by Board members, being attributed only to a small extent to incidental factors and mostly to structural causes likely to affect the external competitiveness of the economy.
Looking at labour market, Board members concluded that in 2021 Q4 it had reflected influences from the persistent bottlenecks in global supply chains and the higher energy and other commodity costs, as well as those from the fourth pandemic wave. It was pointed out that the number of employees economy-wide had almost stopped its increase in October-November, while the ILO unemployment rate had climbed to 5.4 percent in December, after having been stuck to 5.2 percent for a few months – very slightly above the pre-pandemic level, but visibly above the historical low touched in mid-2019, according to the revised historical data series. Moreover, the annual growth rate of average gross nominal wage earnings had gone only marginally up October through November versus the Q3 average, solely on the back of developments in the budgetary sector, given, inter alia, firms’ higher resort to short-time work schemes during that period.
However, labour shortage had seen a faster increase in January 2022 – climbing even more above the historical average, while still remaining significantly below the peak reached in 2019 – and the surveys showed more solid employment intentions over the near-time horizon, albeit divergent from sector to sector, several Board members pointed out. It was deemed that such a context could entail pressures on the renegotiation of wages in early 2022, at least in the case of those sectors facing chronic labour shortage, including amid the fast rise in the inflation rate. Moreover, Board members cited the influences, albeit relatively modest, stemming from the hike in the economy-wide gross minimum wage, but also the opposite effects probably caused by the public-sector wage policy envisaged for the current year.
At the same time, Board members were of the opinion that notable uncertainties continued to surround labour market developments in the near run, given the bottlenecks in production and supply chains (tending however to gradually ease), very high energy and commodity costs, likely to weigh heavily on some sub-sectors’ activity, as well as the still rising tide of the new pandemic wave, triggered by the more contagious Omicron variant of the coronavirus. The risks induced by that variant were, however, cushioned by its lower virulence, alongside the lower severity of related restrictions, including in many European countries, as well as by the enhanced capacity of firms to operate in such a context and the extension of government’s job retention schemes, according to several Board members.
Over the longer time horizon, uncertainties were also associated with the ability of some businesses to remain viable after the cessation of government support measures, as well as in the context of higher costs of energy and transport, but also of the need for technology integration, possibly leading to restructuring or winding-up. The implications of domestic and international automation and digitalisation, spurred by the pandemic outbreak, as well as those of an increasingly higher resort by employers to workers from outside the EU remained also relevant for future labour market conditions.
Turning to financial market conditions, Board members observed that the main interbank money market rates had remained relatively steady following the policy rate hike, at levels close to two-year highs. At the same time, yields on government securities had almost stopped their overall upward movement, although staying significantly above the steadily rising ones in the region, particularly on longer maturities.
Moreover, on the back of a temporary improvement in the international financial market sentiment, the EUR/RON exchange rate had posted a slight downward adjustment in January, albeit far more modest than those recorded in the region, amid larger hikes in key rates implemented by central banks. Also in that context, risks to the leu’s exchange rate were elevated and with potential adverse implications for inflation and external vulnerability indicators, Board members cautioned. They referred to the widening external imbalance and the uncertainties surrounding budget consolidation, as well as to prospects for a faster normalisation of the monetary policy conduct by major central banks, the Fed in particular, but also to the Russia-Ukraine geopolitical situation.
Board members also remarked the steadily rising annual growth rate of credit to the private sector, which had reached 14.8 percent in December 2021, due to the step-up in the dynamics of the leu-denominated component to 19.6 percent, supported inter alia by government programmes. Reference was also made to the sizeable flow, close to the historical high, of leu-denominated housing loans and to the significantly increasing new business to non-financial corporations, as well as to the wider share, i.e. 72.4 percent, held by the stock of domestic currency loans in total private sector credit.
As for future macroeconomic developments, Board members discussed at length the new forecast scenario, showing that – in the context of the available data and the regulations in force – it highlighted a considerable worsening of the inflation outlook, almost exclusively over the short term.
Specifically, the annual inflation rate was expected to significantly accelerate its growth in 2022 Q2 – to 11.2 percent in June versus 8.6 percent in the previous projection – and decrease only gradually over the following three quarters, on a much higher-than-previously-anticipated path, remaining in December 2022 at 9.6 percent against 5.9 percent in the prior forecast. However, it was foreseen to witness a relatively steep downward adjustment in the first part of 2023, due to sizeable base effects, and return inside the variation band of the target in 2023 Q4, only slightly later than previously expected, dropping in December to 3.2 percent, marginally below the November 2021 projection.
The renewed considerable worsening of the inflation outlook continued to be entirely attributable to adverse supply-side shocks, particularly external ones, Board members repeatedly underlined. It was observed that the main additional inflationary effects were expected from far higher increases in natural gas and electricity prices, which would become strongly manifest after the withdrawal in April of compensation schemes for household consumers. They would probably be followed by several increases of a low magnitude in 2022 H2, warranted by the renewal of contracts with suppliers, and would be accompanied by additional influences, albeit much more modest, anticipated from the other exogenous CPI components – fuels, tobacco products, administered prices and VFE.
In the context of compensation schemes presumed to be applied until March 2022, the annual inflation rate was expected to decline very mildly January through March, before witnessing a significant leap and peaking in April, once prices returned to contractual levels, Board members remarked. It was acknowledged, however, that there were high uncertainties about the future characteristics of the support measures, with public information indicating the possibility, inter alia, of a three-month extension of the compensation and capping scheme in force. But, even assuming such a hypothetical scenario, the annual inflation rate could rise to a double-digit value in 2022 Q3, with its significant deviation from the variation band of the target being expected to go on for another quarter compared with the baseline scenario, Board members observed.
At the same time, it was shown that high uncertainties were still associated with how the impact of support schemes would be assessed and included in the CPI calculation. Moreover, it was agreed that the overall balance of supply-side risks to the inflation outlook remained slightly tilted to the upside in the short run, mainly in the case of energy and agri-food prices, also amid the Russia-Ukraine geopolitical situation.
Against that background, Board members expressed serious concerns about the prospects for the annual inflation rate to climb to a two-digit level in Q2 – for the first time ever since the NBR had shifted to direct inflation targeting –, as well as about the inflation dynamics probably staying way above the variation band of the target until towards mid-2023. Members were of the unanimous opinion that such developments called for a larger size of the key rate hike, in order to anchor inflation expectations over the medium term and prevent the start of a self-sustained increase in the overall level of consumer prices – possibly via a wage-price spiral –, but also from the perspective of central bank credibility. At the same time, it was reiterated that any potential central bank attempt to ward off the direct inflationary effects of adverse supply-side shocks would be not only ineffective, but even counterproductive, in view of the sizeable losses it would cause to economic activity and employment over a longer horizon.
Nevertheless, underlying inflationary pressures were expected to be much more modest than previously anticipated and gradually weakening as of 2022 H2, Board members concluded, given the considerably lower values of excess aggregate demand anticipated over the forecast horizon, amid the recent significant downward revisions of statistical data and GDP growth estimates for 2021, but also forecasts for 2022 and 2023.
Conversely, supply-side shocks would probably have relatively stronger direct and indirect effects on core inflation in the short run as well, Board members remarked, especially the hike in agri-food and energy commodity prices, but also the disruptions in production and supply chains, further compounded by high short-term inflation expectations and by the significant size of imports. Under the circumstances, the annual adjusted CORE2 inflation rate would probably continue to increase to a 5.3 percent high at the end of 2022 Q1, visibly above the previously-anticipated 4.8 percent peak. Afterwards, it would embark in the latter part of 2022 on a somewhat more pronounced downward path than forecasted earlier and decline at the end of the projection horizon to 3.2 percent, marginally below the November forecast.
Looking at the future cyclical position of the economy, Board members observed that, after having probably reached very high dynamics from a historical perspective in 2021, yet significantly lower than previously forecasted, economic growth was expected to decelerate considerably in 2022 and 2023. The loss of momentum was seen to be even stronger than anticipated in November 2021, inter alia amid somewhat more moderate expansionary effects envisaged from the absorption of EU funds under the Next Generation EU instrument. The evolution implied much lower-than-previously-estimated values of excess aggregate demand across the forecast horizon, with the positive output gap gradually shrinking as of mid-2022 and nearly closing at the end of the projection horizon, even amid markedly slower potential GDP dynamics.
It was noted that private consumption would remain the major driver of GDP advance, given its relatively robust dynamics anticipated across the projection horizon, only somewhat more moderate than previously forecasted, due inter alia to the increase during 2022 in social transfers and in the gross minimum wage economy-wide, but also amid the step-up in inflation, the gradual rise in bank rates and the fiscal consolidation progress.
Gross fixed capital formation could post significantly more modest dynamics than in the earlier forecast, primarily during 2022, yet faster than the pre-pandemic average, Board members remarked. That would owe to the probable increase in public capital expenditure, also with a contribution from EU funds, and to the presumed stimulative effect on the private sector, but also to the dampening influences stemming from costlier energy and building materials, as well as from bottlenecks in production chains and the relative tightening of financial conditions.
By contrast, net exports were anticipated to exert a minor contractionary impact in both 2022 and 2023, considerably smaller than in 2021. The outlook on the current account deficit saw, however, a relative worsening. Specifically, the external deficit as a share of GDP had probably followed a sharper-than-expected uptrend in 2021, exceeding European standards even further, while in 2022 and 2023 it was expected to witness only mild downward corrections, inter alia amid the persistence of constraints on domestic output and of unfavourable dynamics of international prices for commodities and goods. The outlook was viewed as particularly worrisome by Board members and with potential adverse effects on inflation, but also on economic growth sustainability.
At the same time, it was assessed that the energy crisis – possibly worsened by the Russia-Ukraine conflict – and the supply bottlenecks continued to act as major sources of uncertainties and risks, through their potential impact at global/European level, as well as domestically, on consumer demand and on firms’ activity and investment plans. That was likely to affect short-term developments in aggregate demand, but also the economy’s growth potential over a longer horizon.
Furthermore, Board members reiterated their concerns about the outlook on the absorption of EU funds, especially those under the Next Generation EU programme. Reference was made both to the strict conditions that had to be met for tapping such funds and to their major importance for carrying out the structural reforms and the investments needed by the Romanian economy, as well as for counterbalancing, at least in part, the impact of the gradual budget consolidation.
It was deemed that uncertainties continued to stem also from the evolution of the pandemic, given the still rising tide of the current wave, triggered by the more contagious Omicron variant of the coronavirus, yet less virulent, implying a lower and abating severity of related restrictions, including in many European countries.
The fiscal policy stance remained, however, a significant source of uncertainties and risks to the forecasts, Board members agreed. They highlighted, on one hand, the 2021 government deficit smaller than the target and, on the other hand, the requirement for further fiscal consolidation in line with the commitments under the excessive deficit procedure, yet in a challenging economic and social environment domestically and globally, marked by the energy crisis and geopolitical tensions, as well as by the tightening trend of financing conditions.
Board members were of the unanimous opinion that the analysed context warranted a 0.50 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.
Moreover, it was deemed necessary to maintain firm control over money market liquidity, while the importance of further closely monitoring domestic and global developments was reiterated, 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 2.50 percent from 2.00 percent. In addition, it decided to raise the lending (Lombard) facility rate to 3.50 percent, from 3.00 percent, and the deposit facility rate to 1.50 percent, from 1.00 percent, as well as 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.