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 inflation, Board members showed that the annual inflation rate had continued to increase in September, thus going up in Q3 too – to 15.88 percent from 15.05 percent in June –, compared to the levelling-off anticipated in August. Board members noted that the pick-up had been however much more subdued than in the previous quarters, given that the exogenous CPI components had had a disinflationary contribution overall during that period, mainly following the drop in fuel prices amid motor fuel price compensation and lower crude oil prices; additional influences had stemmed from the base effects associated with the developments in tobacco product prices, as well as in energy prices, mitigated however by the changes made to the electricity price capping scheme as of September.

At the same time, the annual adjusted CORE2 inflation rate had increased at a slower pace than in the first part of the year, but had seen significant, larger-than-anticipated hikes in Q3 too, to 11.9 percent in September from 9.8 percent in June. Nevertheless, the contribution from the processed food sub-group to the advance had touched a record high in recent quarters, mainly reflecting the hikes in commodity and energy prices, while the contribution from non-food items had remained relatively modest, albeit on the increase, and that from the services sub-group had become marginally negative, inter alia amid a base effect and the annual change in the EUR/RON exchange rate, Board members noted.

Following the analysis, it was agreed that the further upward movement in the annual core inflation rate had still been ascribable to global supply-side shocks – amplified and extended by the war in Ukraine and the associated sanctions –, but also to widespread drought in Europe in the current year. Their direct and indirect inflationary effects had continued to be compounded in Q3 too by the high short-term inflation expectations, the resilience of demand in certain segments, as well as by the significant share of food items and imported goods in the CPI basket. The inflationary impact of supply-side shocks continued to be strong and even rising in Europe, including on core inflation, several Board members pointed out, citing the significant number of European countries reporting faster consumer price growth rates than in Romania.

However, Board members also underlined the more subdued advances seen in Q3 by the growth rate of industrial producer prices on the domestic market for the consumer goods segment, on the back of the deceleration in durables price dynamics, as well as the downward adjustments over the last months in the short-term inflation expectations of economic agents. Those adjustments had been significant in trade and construction, down from the elevated levels reached in mid 2022, and more modest in industry and services, yet from relatively lower levels. Reference was also made to the slight downward revision made in September-October to longer-term inflation expectations of financial analysts, which remained however visibly above the variation band of the target, as well as to the increasingly obvious erosion trend of the consumer purchasing power, reflected in the faster negative dynamics of the average net real wage in the first two months of Q3.

As for the cyclical position of the economy, Board members noted that the new provisional version of statistical data reconfirmed the significantly stronger-than-expected economic growth in 2022 Q2, albeit considerably slower versus the previous three months – to 1.8 percent from 5.3 percent –, which implied a new moderate rise in the positive output gap in that period.

The slight deceleration in annual GDP growth in Q2 was also reconfirmed, to 5.1 percent from 6.4 percent in Q1, yet amid a substantial change in the structure of aggregate demand. Thus, according to the incoming data, the largest contribution to economic growth had come from household consumption, which had seen marginally faster annual dynamics. The modest, but increasing contribution from gross fixed capital formation had come in second, yet trailing far behind, whereas the contribution of the change in inventories had turned negative again during that quarter.

At the same time, net exports had made a marginally larger positive contribution to GDP growth, contrary to previous assessments, given the further differential between the annual dynamics of exports of goods and services, in terms of volume, and those of imports thereof, both of which had seen a slight decrease against Q1. Consequently, the fast annual pace of increase of the negative trade balance had posted a mild slowing in Q2, inter alia in the context of the relative narrowing of the unfavourable differential between the upward change in import prices and that in export prices, while the annual growth of the current account deficit had halved compared to the Q1 average, given also the improvement in the evolution of the primary income balance.

As for the near-term outlook, Board members agreed that economic activity was likely to post a quasi-standstill in 2022 H2, under the impact of the escalating war in Ukraine and the extension of the associated sanctions. The developments implied a relatively faster contraction of excess aggregate demand during that period and its fall at year-end to a level only marginally higher than previously anticipated, but also a rise in the annual dynamics of GDP in Q3, amid a base effect.

It was noted that the latest high-frequency indicators showed, however, a notable deceleration in the annual increase in private consumption in Q3, yet concurrently with a strong pick-up in gross fixed capital formation compared to the same year-earlier period. The contribution of net exports could become again slightly negative during that period, as the marked acceleration in the annual change in imports of goods and services in July-August, inter alia amid unfavourable developments in external prices, had been visibly more pronounced than that in exports. That had led also to a renewed considerable step-up in the annual dynamics of the trade deficit compared to the previous quarter’s average, and a somewhat more modest re-acceleration of the annual dynamics of the current account deficit, given the substantial improvement in the primary income balance. Board members voiced again concerns over the deepening trend of the external deficit that had grown in the current year, but largely owing to the worsening of the terms of trade and the impact of incidental factors, seriously affecting many EU economies too, in the context of the energy crisis and the war in Ukraine.

Looking at labour market developments, Board members noted that the number of employees in the economy had stopped its increase in August, given the cut in the number of personnel in the private sector, for the first time in 11 months, while the ILO unemployment rate had seen a renewed slight advance in September, after its almost uninterrupted decrease during the current year to 5.1 percent in August. Moreover, the double-digit annual dynamics of the average gross nominal wage earnings had come to a standstill in July-August at the level seen in Q2, hence leading to a larger negative differential vis-à-vis the annual inflation rate, while the fast annual dynamics of unit wage costs in industry had stepped up further, amid the additional deterioration of labour productivity, in the context of the energy crisis.

At the same time, it was observed that, according to the latest surveys, labour shortage reported by companies had remained in October at the lower level reached in Q3 and that the hiring intentions for the near-term horizon had posted only a slight recovery, after the decrease in the previous months, in the context of mixed sectoral developments, given the very high energy costs as well as the uncertainties generated by the war in Ukraine and the related increasingly strict sanctions, with an impact on demand too.

It was deemed that the relative reduction in labour market tightness, revealed by those data, was likely to put a break on the pick-up in the wage growth rate in the coming future. The high inflation level required however close monitoring of labour market developments, according to several Board members, considering inter alia the entrenched structural problems of the market, as well as the likelihood of future hikes in public and private sector wages, also under the impact of the notable rise as of 1 January 2023 in the economy-wide gross minimum wage.

It was reiterated however that, beyond the near-term horizon, the ability of some businesses to remain viable/profitable in the context of high costs would be probably challenged also by the cessation of government support measures, as well as by the need for technology integration, possibly leading to new restructuring or bankruptcy of firms. In addition, reference was also made to the significant uncertainties surrounding the future labour market conditions stemming from the expansion of automation and digitalisation domestically, alongside a significantly higher resort in the recent months to workers from outside the EU.

Turning to financial market conditions, Board members showed that the main interbank money market rates had resumed growth in October under the influence of the increase in the monetary policy rate, yet at a slower pace. In turn, yields on government securities had advanced more steeply during the first two 10-day periods of the month, before witnessing sizeable downward adjustments, similarly to developments in advanced economies and in CEE countries, amid the improvement in global financial market sentiment and in the risk perception towards the region. At the same time, interest rates on major loan categories had recorded new increases, while the average remuneration of new time deposits had climbed further, including for households, albeit more mildly than in the previous months.

Against that background, as well as amid the relatively high attractiveness of investments in domestic currency, the leu had posted again an appreciation trend versus the euro in October, only partly and temporarily reversed towards the end of the month. Moreover, it was noted that the leu had largely corrected the relatively abrupt depreciation seen in the second part of September versus the US dollar, as the latter had tended to weaken on international financial markets in October, given the revision of investors’ expectations on the near-term pace of monetary policy tightening by the Fed, but also by the ECB.

Risks to the behaviour of the leu’s exchange rate – likely to also affect external vulnerability indicators – came, however, especially from the widening external imbalance and the uncertainties surrounding budget consolidation, as well as from a possible renewed sudden worsening of the risk perception towards financial markets in the region, amid the war in Ukraine and the imposed sanctions. Nevertheless, Board members were of the opinion that opposite influences were expected to further stem from the narrowing of the short-term interest rate differential, given the quasi-halt in key rate hikes by central banks in the region.

At the same time, it was observed that the annual growth rate of credit to the private sector had seen in September a halt in the downward path it had embarked on at the beginning of H2, staying at 16 percent, as the renewed deceleration in the increase of the domestic currency component had been counterbalanced by the sharper uptrend in the dynamics of foreign currency-denominated loans, primarily on account of developments in credit to non-financial corporations. As a result, the share of leu-denominated loans in credit to the private sector had fallen to 70.6 percent in September from 71.8 percent in August.

As for future macroeconomic developments, Board members showed that, according to current assessments, the annual inflation rate was expected to reach a plateau in 2022 Q4, before embarking on a gradual downward path, revised mostly upwards, yet downwards in the middle segment of the forecast horizon. The path was seen declining to one-digit levels in 2024 H1 and steepening afterwards, although remaining slightly above the variation band of the target at the end of the projection horizon. Specifically, after probably hitting 16.3 percent in December 2022 – considerably above the target band and visibly over the previous forecast of 13.9 percent –, the annual inflation rate would shrink gradually, to 11.2 percent in December 2023 and then to 4.2 percent at the end of the projection horizon, versus the 7.5 percent and 2.3 percent previously anticipated for the same moments.

It was observed that the outlook for a reversal in the annual inflation rate path relied on the likely softening of direct and indirect effects of global supply-side shocks, inter alia in the context of energy price capping schemes implemented until August 2023, as well as on increasingly manifest disinflationary base effects associated with the steep hikes recorded earlier by energy, fuel and processed food prices. To those added the influences expected to stem from the declines in some commodity prices, amid the easing of wholesale markets.

Under the circumstances, behind the upward revision of most of the forecasted annual inflation rate path stood the relatively higher dynamics, both recently and implicitly in the period ahead, of processed food and energy prices, prompted by international commodity prices having risen/stuck to values above expectations lately. However, Board members remarked that the heftier inflationary impact of energy commodity prices would become manifest later than in prior assessments and would temporarily re-accelerate the inflation dynamics to a markedly lower-than-previously-anticipated level, following the extension of energy price capping schemes until August 2023. That explained the downward revision of the path in the middle segment of the forecast horizon.

It was repeatedly underlined that the future path of the inflation rate hinged decisively on the duration and features of energy price capping schemes. Thus, it was observed that, assuming an extension thereof, the annual inflation rate could stand at end-2023 around 4 percentage points lower than currently envisaged. Furthermore, it was agreed that supply-side risks to the inflation outlook were tending to balance overall at the current juncture, given the recent developments in key energy and agri-food commodity prices, as well as their major determinants.

At the same time, it was shown that underlying pressures would see their currently mild (albeit stronger-than-previously-anticipated) inflationary impact probably fade out quickly and would become more markedly disinflationary in 2024, given the prospects for a rapid contraction of the positive output gap and its closing in 2023 Q4 – only slightly later than projected in August –, followed by the output gap widening into negative territory at a relatively faster pace.

Nevertheless, Board members concluded that, in the near future, core inflation dynamics would continue to be affected by the stronger inflationary effects from supply-side shocks, particularly those stemming from the further high agri-food commodity prices. They would be compounded by high short-term inflation expectations and by the significant share of processed food and imports in the core inflation basket. Under the circumstances, the annual adjusted CORE2 inflation rate would probably continue to rise until the beginning of 2023, although at an increasingly slower pace, reaching 13.6 percent in December 2022 versus 11.4 percent in the prior forecast. Afterwards, it would decline progressively, to stand at 7.9 percent in December 2023 and 4.0 percent at the end of the projection horizon, compared to the previously-anticipated 5.5 percent and 3.8 percent respectively.

Looking at the future cyclical position of the economy, Board members observed that economic activity would probably record higher-than-previously-foreseen dynamics in 2022, yet solely as a result of the above-expectations performance in H1. Economic growth would then decelerate markedly in 2023 and witness only a slight revival in 2024, owing to the protraction of the war in Ukraine and the broadening of related sanctions, as well as amid the monetary policy stance and the fiscal consolidation, only partly counterbalanced by the effects from the absorption of EU funds under the Next Generation EU instrument. The outlook implied a relatively more sizeable turnaround in the output gap pattern. Specifically, after having seen a renewed increase in its positive value in 2022 Q2, contrary to forecasts, the output gap was envisaged to narrow relatively quickly and fall more briskly into negative territory starting in 2023 Q4.

It was shown that private consumption would probably remain the major driver of GDP advance, yet amid the significant slowdown in its growth during 2022 H2 and especially in 2023, particularly against the background of high inflation and labour market developments, as well as under the influence of the rise in lending and deposit rates for households.

A considerable loss of momentum was expected in 2022 H2 for gross fixed capital formation as well, followed however by a re-acceleration in 2023, Board members concluded. They referred to the heightened uncertainties and the effects generated domestically and globally by the escalation of the war in Ukraine, as well as to the tightening trend of financial conditions worldwide, but also to the probable step-up in EU funds absorption in 2023, inter alia via the Next Generation EU programme, conducive to fostering public investment also in the energy and transport sectors, with stimulative effects on the private sector.

Net exports might make a negative contribution to annual GDP dynamics both during 2022 overall and in 2023, albeit significantly on the wane, amid a relatively more pronounced deceleration of the advance in the volume of imports compared to that in the volume of exports of goods and services, correlated mainly with the evolution of domestic absorption. The current account deficit was, however, expected to widen as a share of GDP in 2022 as well, more steeply than in the previous projection, primarily under the influence of the deterioration in the terms of trade. Afterwards, in 2023, following a slight narrowing, it was anticipated to stay significantly above European standards. Board members viewed those developments as particularly worrisome, given the risks to inflation, external financing costs and, ultimately, to economic growth sustainability.

At the same time, Board members highlighted the considerable uncertainties and risks to the outlook for economic activity and to medium-term inflation developments generated by the escalation of the war in Ukraine and the broadening of related sanctions, through the possibly stronger effects exerted on consumer purchasing power and confidence, as well as on firms’ activity, profits and investment plans, but also by potentially affecting more severely the European/global economy and the risk perception towards economies in the region, with an unfavourable impact on financing costs.

Board members repeatedly underlined the importance of absorbing EU funds, especially those under the Next Generation EU programme. That was conditional on fulfilling strict milestones and targets for implementing the approved projects, but was essential for carrying out the necessary structural reforms, energy transition included, as well as for counterbalancing, at least in part, the contractionary impact of supply-side shocks, compounded by the war in Ukraine and by the tightening of economic and financial conditions worldwide.

Major uncertainties and risks were, however, associated with the fiscal policy stance as well, Board members agreed. They referred to the budget execution in the first nine months of the year, as well as to the potential budget impact of the support measures for households and firms implemented at the current juncture, but also to the requirement for further budget consolidation amid the excessive deficit procedure and the overall uptrend in the cost of financing. From that perspective, the characteristics of the upcoming budget revision in 2022 and the coordinates of the 2023 draft budget were deemed as particularly important. Moreover, it was shown that, under the current circumstances, a balanced macroeconomic policy mix and the implementation of structural reforms to foster the growth potential over the long term were of the essence in preserving a stable macroeconomic framework and strengthening the capacity of the Romanian economy to withstand adverse developments.

Board members were of the unanimous opinion that the reviewed context overall called for 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 the annual inflation rate back 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. They underlined again the importance of the dosage of measures and of the calibration of the monetary policy conduct at the current juncture for effectively anchoring inflation expectations while minimising costs in terms of economic growth, given also the major contractionary effects generated by the sizeable supply-side shocks, the energy crisis in particular, but also the requirement for fiscal consolidation progress.

Moreover, Board members advocated the need to maintain firm control over money market liquidity and 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 increase the monetary policy rate to 6.75 percent from 6.25 percent. Moreover, it decided to raise the lending (Lombard) facility rate to 7.75 percent from 7.25 percent and the deposit facility rate to 5.75 percent from 5.25 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.