Minutes of the monetary policy meeting of the National Bank of Romania Board on 5 October 2023

Publishing date: 19 October 2023     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 decline in the first two months of 2023 Q3 overall, in line with forecasts, going down to a one-digit level in July and reaching 9.43 percent in August from 10.25 percent in June. It was observed that the evolution of exogenous CPI components had become again marginally inflationary over that period, given that the larger-than-expected fall in VFE prices and the further drop in energy price dynamics had been outweighed, in terms of impact, by the hike in fuel prices and the spike in medicine prices.   In contrast, the annual adjusted CORE2 inflation rate had seen a faster decrease, falling slightly below the forecast to reach 12.0 percent in August, from 13.5 percent in June. That had owed mainly to a further fast deceleration in the growth rate of processed food prices, but also to the slower increases in the dynamics of non-food prices and services prices, Board members noted.   Following the analysis, it was agreed that the decline in the annual core inflation rate had been primarily attributed to disinflationary base effects, downward adjustments in commodity prices, especially agri-food items, as well as to the measure to cap temporarily the mark-ups on basic food products implemented in August.   Nevertheless, the pass-through of higher corporate costs, especially wage costs, into consumer prices had lost momentum and the inflationary impact of imports had eased, according to several Board members. In that context, reference was also made to the recent movements in industrial producer prices on the domestic market, the annual growth rate of which had continued to decelerate at a fast pace for the consumer goods segment July through August.   At the same time, however, it was observed that in August-September short-term inflation expectations of economic agents had stopped their steep decline seen during the previous two quarters, actually reporting small upward adjustments, while financial analysts’ longer-term inflation expectations had remained relatively stable above the variation band of the target, after the decrease in the first month of Q3. Moreover, the consumer purchasing power had continued to recover in June-July, albeit at a much slower pace, reflecting the annual dynamics of the net real wage over that period, some Board members pointed out.   As for the cyclical position of the economy, Board members showed that economic growth had sped up in 2023 Q2 to 0.9 percent, from 0.5 percent in the previous three months, above expectations, which made it likely for excess aggregate demand to stop its contractionary trend over that period.   Conversely, in annual terms, GDP growth had posted a new significant decline, also compared to forecasts, to reach 1.1 percent in Q2, from 2.4 percent in the first three months of the year. In addition, it was remarked that the decline had been driven that time round by household consumption, whereas gross fixed capital formation had seen a re-acceleration in its double-digit annual growth, following the faster dynamics of civil engineering works, but especially of equipment purchases. At the same time, net exports had exerted a larger expansionary impact, given the further widening of the positive differential between the annual dynamics of exports of goods and services, in terms of volume, and those of imports, amid the latter falling more visibly into negative territory. Against that background, both trade deficit and current account deficit had continued to narrow substantially versus the same year-earlier period, Board members underlined.   Looking at the labour market, Board members noted that, according to the new data and surveys, the job vacancy rate had fallen markedly in 2023 Q2, after having risen significantly in the previous quarter, while the ILO unemployment rate had remained flat at 5.5 percent until July and had declined only marginally in August. Moreover, the monthly increase in the number of employees economy-wide had slowed down in June-July, chiefly on the back of private sector developments, and employment intentions over the very short horizon had receded visibly in August-September, from the levels close to historical highs reported previously, while the labour shortage reported by companies had risen in Q3 on account of developments in industry and services.   It was also noted that the double-digit annual dynamics of the average gross nominal wage had lost momentum in 2023 Q2 overall and in July, whereas those of unit labour costs in industry had declined slightly since May. Nevertheless, the dynamics remained particularly high and worrisome from the perspective of inflation, Board members underlined.   At the same time, it was shown that additional pressures on wage costs in the private sector could stem, in the short run, from an increase in the minimum wage and the likely removal of some tax breaks, alongside the persistence of the mismatch between labour demand and supply, at least in some segments, inter alia, amid structural labour market deficiencies. However, firms’ elevated costs and tighter financial conditions, as well as the downward path of the inflation rate and the higher resort by employers to workers from outside the EU would likely act in the opposite direction, several Board members reiterated. Moreover, the increases in unit wage costs could be absorbed, at least partially, in profit margins, as shown by some companies’ recent practice, given the more cautious consumer behaviour, some Board members argued.   Turning to financial conditions, Board members showed that the main interbank money market rates had halted their slowly downward path in mid-August, while yields on government securities had extended their upward course – in line with developments in advanced economies and in the region – amid investor expectations on the Fed keeping policy rates higher for longer, likely to affect global risk appetite as well.   Against that background, as well as amid the unexpectedly sizeable cut in the key rate by the National Bank of Poland, the EUR/RON exchange rate had climbed relatively abruptly in the first part of September, similarly to the exchange rates of currencies in the region, before tending to stabilise at the new readings. At the same time, the domestic currency had posted a notable depreciation versus the US dollar, amid the latter’s strengthening trend on international financial markets, reflecting the better performance of the American economy.   Risks to the behaviour of the leu’s exchange rate remained high, Board members deemed, referring to the still considerable size of the external disequilibrium and the uncertainties associated with fiscal consolidation, as well as to the narrower domestic interest rate differential vis-à-vis developed countries and the prospective monetary policy stance of the Fed and the ECB.   At the same time, Board members noticed that the annual growth rate of credit to the private sector had continued to slow down in the first two months of Q3, but more mildly, reaching 5.5 percent in August from 6.4 percent in June, as the leu-denominated component had lost pace only marginally and the relatively swift decrease in the dynamics of the foreign currency component had been cushioned in terms of impact by the statistical effect of EUR/RON exchange rate movements.   Therefore, the share of leu-denominated loans in credit to the private sector had edged up further, to 68.2 percent in August from 67.9 percent in June. As for future developments, Board members showed that, according to the new assessments, the annual inflation rate would continue to fall until end-2023 in line with the latest medium-term forecast, published in the August Inflation Report, which had anticipated its decline to 7.5 percent in December 2023, to 4.4 percent in December 2024 and to 3.8 percent at the end of the projection horizon.   It was observed that the expected decrease in the annual inflation rate was further attributable to supply-side factors, especially base effects and downward adjustments of some commodity prices, mainly of agri-food items, but also to the rich vegetable and fruit crop domestically and the temporary cap on the mark-ups on basic food products, presumed to be extended by another three months.   The disinflationary effects thus exerted would be manifest particularly in the energy segment and in that of food items – both processed and with volatile prices –, further affecting inter alia the core inflation dynamics. Overall, those effects would be stronger in the near run than previously envisaged and counterbalanced only to a small extent by the relatively more pronounced pick-up in the dynamics of fuel prices, amid the steeper-than-expected rise in oil prices, Board members remarked.   Beyond the near-term horizon, the balance of risks stemming from the action of supply-side factors was, however, obviously tilted to the upside, given the prospective increase and introduction at the onset of 2024 of some indirect taxes for furthering budget consolidation. Their inflationary impact, although relatively modest and transitory, would push in the short run the decreasing path of the annual inflation rate higher than that shown in the August forecast, seen running still considerably above the variation band of the target, Board members pointed out in several interventions. Inflationary influences could also come over the short term from recently approved changes in direct taxes and removal of some tax breaks, as well as from the potential successive rise in the minimum wage level, likely to affect corporate costs, several members deemed.   At the same time, it was agreed that the cyclical position of the economy was envisaged to exert stronger inflationary pressures, yet more markedly on the wane over the near term than in the previous projection, as the new assessments pointed to a significant deceleration of quarterly GDP growth in the second part of the year, also compared with forecasts, after the above-expectations advance in Q2. The developments implied a relatively swifter narrowing of excess aggregate demand in 2023 H2 and its reverting at year-end back in line with the August forecast, but also a recovery of the annual GDP dynamics from the low level reached in Q2, Board members remarked.   Moreover, it was observed that, according to high-frequency indicators, gross fixed capital formation had probably remained in Q3 the main driver of economic growth, while a new expansionary impact, even on the rise, could be exerted by net exports, given the further widening of the positive differential between the annual dynamics of exports of goods and services and those of imports in the first month of Q3. Against that background, trade deficit had seen a considerably faster annual decline in July, whereas the current account deficit had recorded a significantly slower year-on-year narrowing, mainly as a result of the worsening in the primary income balance, Board members noted.   Beyond year-end, uncertainties and risks to the outlook for economic activity, hence to medium-term inflation developments, stemmed however from the future fiscal policy stance and the package of fiscal and budgetary measures envisaged to be implemented in 2024. Those would be conducive to the swifter weakening and exhaustion of underlying inflationary pressures and to the earlier return of the inflation rate inside the variation band of the target compared with the August forecasts, Board members repeatedly showed.   At the same time, the fiscal adjustment programme would enhance the correction of the current account deficit, together with the cut in the fiscal deficit, with favourable implications also for the financing costs of the economy and the behaviour of the leu’s exchange rate, Board members reiterated. They also highlighted the relevance of this programme in light of the excessive deficit procedure and the commitments made, but also of the conditionalities attached to other agreements signed with the EC.   In that context, Board members underscored again the importance of absorbing and effectively using EU funds, especially those under the Next Generation EU programme, which were essential for carrying out the necessary structural reforms and energy transition, as well as for raising the growth potential and strengthening the resilience of Romania’s economy.   Furthermore, mention was made of the uncertainties and risks to the prospects for economic activity, implicitly to medium-term inflation developments, generated by the war in Ukraine and the below-expectations performance of European economies in the recent period.   Board members were of the unanimous opinion that the reviewed context overall warranted keeping the monetary policy rate unchanged, 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, inter alia by anchoring medium-term inflation expectations, in a manner conducive to achieving sustainable economic growth.   Moreover, Board members 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 keep the monetary policy rate at 7.00 percent. Furthermore, it decided to leave unchanged the lending (Lombard) facility rate at 8.00 percent and the deposit facility rate at 6.00 percent. 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.