Minutes of the monetary policy meeting of the National Bank of Romania Board on 5 April 2022

15 April 2022   The National Bank of Romania Board members present at the meeting: Mugur Isarescu, 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 Nicolaescu, 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 Rusanu, Board member; 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.   Looking at the recent developments in inflation, Board members showed that the annual inflation rate had continued to rise gradually in the first two months of 2022, contrary to forecasts, climbing to 8.53 percent in February, from 8.19 percent in December 2021, even though the exogenous CPI components had had a disinflationary contribution overall, given that the slower pace of increase of electricity and natural gas prices – amid a base effect and extended price compensation and capping schemes – had outweighed considerably the impact of the larger-than-anticipated hikes in fuel prices, VFE prices and administered prices.   Conversely, the annual adjusted CORE2 inflation rate had followed a sharper upward path, also compared to forecasts, to reach 5.9 percent in February from 4.7 percent in December 2021. However, its advance had been yet again triggered mainly by processed food prices, amid the significantly faster-than-expected broad-based increases in prices, under the impact of the hikes in commodity prices, as well as higher energy and transport costs.   The more modest contributions made by the non-food and services subcomponents had been, however, higher than in the previous quarter, several Board members noted, given the more widespread and stronger increases in those prices. That had most likely been in correlation with the pick-up in the prices of imported goods and the additional hike in production costs on the domestic front, alongside a still strong demand for certain services, amid, inter alia, the low severity of the fifth pandemic wave and the associated restrictions.   Following the analysis, Board members agreed that the recently faster upward movement of annual core inflation rate was also ascribable to supply-side shocks, particularly to external ones, whose direct and indirect effects had been compounded by increasingly higher short-term inflation expectations, the resilience of demand for certain services, as well as by the significant share of food items and imported goods in the CPI basket.   During the discussions, Board members referred to the sharper 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 conditions, into the prices of almost all consumer goods and services.   Furthermore, mention was made of the new significant upward adjustments in economic agents’ short-term inflation expectations, accompanied by a very recent notable increase in financial analysts’ longer-term inflation expectations, as well as of the already applied government measures to support consumer purchasing power that would underpin, alongside larger social transfers, the recovery of the dynamics of households’ real disposable income at the onset of 2022.   As for the cyclical position of the economy, Board members showed that in 2021 Q4 economic activity had continued to weaken more than expected, falling by 0.1 percent versus the previous three months, but solely on the back of the marked deterioration in the performance of agriculture. It was concluded that the developments made it likely for excess aggregate demand to remain very low during that period, in line with the February 2022 forecast, given, inter alia, the implications of the new revision of statistical data on GDP developments in 2020 and 2021.   Moreover, it was remarked that annual GDP dynamics had seen in 2021 Q4 a markedly stronger-than-anticipated decline, i.e. to 2.4 percent from 6.9 percent in Q3, but almost entirely on the back of the contribution of the change in inventories falling to a significantly negative value.   Household consumption had made only a slightly lower positive contribution, while gross fixed capital formation had recorded a somewhat improved contribution, although its annual dynamics had remained marginally negative, mainly following the contraction, in annual terms, in net investment in equipment.   At the same time, net exports had seen their contractionary impact diminish, as the decrease in the annual change in imports of goods and services had exceeded that in exports thereof. Against that background, the annual increase in the negative trade balance had decelerated considerably as against 2021 Q3, due also to the narrowing of the unfavourable differential between the upward dynamics of import prices and those of export prices.   Conversely, the current account deficit had widened in annual terms at a significantly faster pace, under the impact of the worsening of the secondary income balance, on account of a decrease in inflows of EU funds to the current account as compared to the same year-earlier period.   The ensuing rise in the current account deficit to 7.0 percent of GDP in 2021, from 5.0 percent in 2020, was viewed as particularly worrisome by Board members, even if it could be partly attributed to the deterioration of the terms of trade and other incidental factors, whereas its coverage by direct investment and capital transfers had increased mildly, remaining however relatively low.   Moreover, it was remarked that the 5.9 percent economic advance in 2021 had been overwhelmingly driven by private consumption and that the change in inventories had made a relatively large contribution, whereas the significantly lower contribution of gross fixed capital formation had not exceeded that in the previous year.   Looking at the labour market, Board members underlined the recent mixed developments, as well as the need for a further close monitoring of the parameters of that market. It was pointed out that the number of employees economy-wide had increased slightly in December 2021 and January 2022, reaching a record high, whereas the ILO unemployment rate had climbed to 5.7 percent in December 2021 – after its drop to 5.4 percent in Q3 –, remaining unchanged in the first two months of 2022, i.e. significantly above the historical low reached in the summer of 2019.   At the same time, the annual dynamics of the average gross nominal wage earnings had gained only modest momentum in early 2022, although somewhat more pronounced in the private sector. The labour shortage reported by companies had posted a faster increase January through March 2022, from a level, however, considerably below its mid-2019 peak; moreover, the hiring intentions for the near-term horizon, as shown by surveys, had risen in January-February, but had seen a moderate downward adjustment in March.   It was deemed that, in that context, upward wage pressures could become manifest, at least in the sectors facing difficulties in recruiting skilled labour, especially amid the high and rising growth rate of inflation. Public-sector wage policy envisaged to be maintained in the current year was nevertheless expected to curb pay growth, alongside the notably higher commodity, energy and transport costs, which would probably make it difficult to fully meet potential substantial wage claims, according to several Board members.   In addition, it was agreed that the uncertainties and risks to labour market developments were considerably enhanced, in the near run, by Russia’s invasion of Ukraine and the retaliatory international sanctions likely to exacerbate the energy crisis and the production and supply chain disruptions and to accelerate the rise in the prices of other goods. However, their impact on market parameters would probably be mitigated by government support measures – envisaging, inter alia, firms’ energy costs and the situation of the employees of sanctioned companies –, but also by the lifting of all mobility restrictions in early March, with the end of the state of alert, some Board members deemed.   For the somewhat 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 speed and effects of domestic and international automation and digitalisation, as well as the implications of an increasingly higher resort by employers to workers from outside the EU were also relevant for future labour market conditions.   Turning to financial market conditions, Board members showed that the main interbank money market rates had witnessed a faster pick-up in February and March, reaching nine-year highs, following the new monetary policy rate hike, as well as amid the pronounced tightening of liquidity conditions and expectations on a further increase in the key rate. Moreover, members noted the strong rises recorded by yields on government securities in the early days of March, only partly corrected afterwards, given the abrupt deterioration of financial investor sentiment, especially vis-à-vis markets in Central and Eastern Europe, following the outbreak of the war in Ukraine and the imposition of international sanctions.   At that juncture, the EUR/RON exchange rate had also posted an upward adjustment, albeit far more modest than those observed in the region, before quasi-stabilising at the new levels, in the context of the NBR’s liquidity management actions, but also amid the subsequent relative abatement of volatility on the international financial market.   However, risks to the leu’s exchange rate remained elevated and with potential consequences for inflation and external vulnerability indicators, Board members cautioned. They referred to the size of the external imbalance and the risks to budget consolidation induced by the war in Ukraine, as well as to the prospects for a faster normalisation of the monetary policy conduct by major central banks, the Fed in particular, and to the fast-paced increase in key rates by central banks in the region, inter alia amid the worsening risk perception towards economies in the vicinity of the military conflict.   Board members also observed that the average lending rate on new business had embarked on a firmly upward path in January, also as a result of the increase in the IRCC, which would steepen as of Q2, while the average remuneration of new time deposits had seen a slight pick-up, January through February, in the rise recorded since 2021 Q3 – visibly slower, however, and largely attributable to the non-financial corporations sector. At the same time, it was noted that the double-digit annual growth rate of credit to the private sector had climbed further during the first two months of 2022, reaching 15.8 percent in February, mainly on account of developments in leu-denominated loans to non-financial corporations. Hence, the share of the domestic currency component in total had widened to 72.5 percent.   As for future developments, Board members showed that, according to the new assessments, the annual inflation rate would probably rise somewhat more steeply in the coming months than anticipated in the February medium-term forecast. The latter had indicated a pick-up to 11.2 percent in June, followed by a gradual decrease, to 9.6 percent in December 2022, and a steeper downward adjustment in 2023 H2, implying its drop to 3.2 percent at end-2023.   The renewed worsening of the near-term inflation outlook continued to be attributable to adverse supply-side shocks, Board members underlined. They remarked that, in the current context, its main determinants were the much higher increases expected for fuel prices, and especially for processed food prices, mainly due to the stronger advance in crude oil and agri-food commodity prices, amid the war in Ukraine and the international sanctions in place. It was observed that the inflationary effects thus exerted were foreseen to prevail in the near term over the substantial disinflationary impact presumably generated by the one-year extension of capping schemes for electricity and natural gas prices for households. Moreover, it was noted that additional inflationary effects would primarily affect the dynamics of core inflation, given inter alia the large share held by processed food items in the latter’s basket.   At the same time, it was agreed that significant uncertainties were still associated with how the impact of support schemes would be assessed and included in the CPI calculation. Furthermore, the overall balance of supply-side risks remained tilted to the upside, at least in the short run, amid the war in Ukraine and the associated sanctions, with potential more severe implications for oil and agri-food commodity prices, as well as for production and supply chains.   Following the analysis, Board members were of the unanimous opinion that the near-term inflation outlook and the risks thereto induced by global supply-side shocks called for a further key rate hike of 0.50 percentage points, 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.   As for demand-side inflationary pressures, Board members observed that current assessments pointed to a slight reacceleration of economic growth in 2022 Q1, followed however by a renewed slowdown in Q2, under the impact of the war in Ukraine and the associated sanctions. Developments implied an ongoing decline during that period in annual GDP dynamics to visibly lower-than-previously-forecasted values and made it likely for excess aggregate demand to stick in 2022 H1 to significantly lower levels than anticipated in February. Thus, the cyclical position of the economy was expected to exert subdued inflationary pressures in the near run, and implicitly softer than previously anticipated, Board members concluded.   Moreover, it was noted that recent developments in high-frequency indicators pointed to private consumption as the major driver behind the decline in annual GDP dynamics during 2022 Q1. Conversely, gross fixed capital formation could make a slightly improved contribution, mainly on account of construction works, while net exports could have a lower negative contribution, as the worsening of the unfavourable differential between the considerably accelerating growth of imports of goods and services and the less steep rise in exports thereof in January had probably owed primarily to adverse developments in external prices.   However, that had resulted in a quasi-trebling of the trade deficit in January versus the same year-earlier period and a record annual increase in the current account deficit, also following the slight deterioration of the primary income balance, several Board members pointed out.   At the same time, it was repeatedly shown that the uncertainties and risks surrounding the medium-term inflation forecast were considerably compounded by the war in Ukraine and the associated sanctions, which could weaken economic activity, but also its growth potential, via multiple channels, especially by worsening the energy crisis and the production chain bottlenecks, as well as via the steeper advance in other prices of goods, primarily agri-food items. It was observed that potential more unfavourable developments in that area could additionally affect both consumer purchasing power and confidence and firms’ activity, profits and investment plans, but also the economy’s dynamics in Europe/worldwide, as well as the risk perception towards economies in the region, with an impact on financing costs.   Against that background, Board members reiterated their concerns about the outlook on the absorption of EU funds, especially those under the Next Generation EU programme, which was conditional on fulfilling strict milestones and targets, but was essential for accelerating structural reforms, energy transition included, as well as for counterbalancing, at least in part, the impact exerted by the war in Ukraine and the associated sanctions, and by the fiscal consolidation.   Nevertheless, members also remarked the recent improvement in the epidemiological situation on the domestic front, which had led to the end of the state of alert and to the lifting of all mobility restrictions earlier than anticipated, with favourable effects on economic activity. In the same vein, reference was made to the implemented/envisaged government measures on safeguarding households’ purchasing power and supporting companies, as well as on stepping up investment in the energy sector and managing the situation of refugees.   Also under those circumstances, Board members agreed that the future fiscal policy stance was a source of heightened uncertainties and risks to the forecasts. They highlighted, on one hand, the requirement for further fiscal consolidation amid the excessive deficit procedure and the tightening trend of financing conditions and, on the other hand, the current challenging economic and social environment domestically and globally, marked by the implications of the war in Ukraine and of the sanctions imposed on Russia.   Board members were of the unanimous opinion that the context under analysis called for a further 0.50 percentage point increase in the monetary policy rate, so as to anchor medium-term inflation expectations 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, 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 3.00 percent from 2.50 percent. In addition, it decided to raise the lending (Lombard) facility rate to 4.00 percent, from 3.50 percent, and the deposit facility rate to 2.00 percent, from 1.50 percent. Furthermore, the NBR Board decided with a majority of votes, i.e. 8 for and 1 against, to maintain firm control over money market liquidity. In addition, 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.