Minutes of the monetary policy meeting of the National Bank of Romania Board on 6 August 2021

16 August 2021   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 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 the annual inflation rate had continued to rise above the upper bound of the variation band of the target in June 2021, implicitly above the forecast, climbing to 3.94 percent from 3.75 percent in May and 3.05 percent in March 2021. It was observed that the pick-up in Q2 had owed almost entirely to the exogenous CPI components, the same as in Q1, with the main contribution made by the larger-than-expected hike in fuel prices amid higher oil prices, followed by the modest influences coming from the increase in the prices of fruit and vegetables, as well as from the rise in tobacco product prices.   Moreover, the annual adjusted CORE2 inflation rate had stopped its downward trend in 2021 Q2, a little earlier than anticipated, moving up marginally to 2.9 percent in June from 2.8 percent in March 2021, given that the small disinflationary base effects on the processed food and non-food segments had been more than offset, in terms of impact, by the renewed pick-up in the growth rate of the services sub-component and by the advance in some food and non-food prices.   Board members agreed that the latter influences could be attributed to a slight step-up in the annual depreciation of the leu against the euro, as well as to the temporary effects of the relatively sharp increase in consumer demand once with the easing of some restrictions, especially for services, overlapping those resulting from supply-side disruptions and costs associated with more expensive commodities and with the measures to prevent the coronavirus spread.   Against that backdrop, mention was made of the forced or precautionary household savings during the social distancing period, as well as of the strong increase in the annual dynamics of real disposable income over the last months, however reflecting also a notable base effect. At the same time, Board members mentioned the steep uptrend in industrial producer prices on the domestic market for consumer goods – inter alia, amid higher energy prices –, as well as the significant rise in short-term inflation expectations reported by many categories of economic agents, but also the relative stability of long-term inflation expectations to date.   As for the cyclical position of the economy, Board members remarked that the second preliminary version of statistical data indicated a 2.9 percent growth in GDP in 2021 Q1 – marginally above that previously mentioned –, and its smaller decline in annual terms to only -0.2 percent from -1.4 percent in 2021 Q4, similarly to the prior estimate, therefore reconfirming the considerably faster-than-anticipated rebound in economic activity in the first three months of the year. Implicitly it reconfirmed an almost full recovery in that period of the economic contraction seen in 2020 Q2, as well as the reopening of the positive output gap two quarters ahead of the May medium-term forecast, Board members stressed.   At the same time, domestic demand was reconfirmed to be the sole driver of the economic upturn, in the context of the strong re-acceleration of household consumption, but also amid the significantly faster increase in gross fixed capital formation, even above the prior estimate. In addition, Board members noted the substantial expansion of the negative contribution of net exports to annual GDP dynamics, similar in size to that previously estimated, given the unfavourable differential between the growth rates of imports and exports of goods and services in 2021 Q1.   Under the circumstances, a more pronounced widening of the trade deficit against the same year-earlier period, and especially the step-up in the annual dynamics of the current account deficit to a 14-quarter high – also in the wake of the notable worsening of the primary and secondary income balances –, were deemed to be a particular cause for concern by Board members.   Turning to near-term prospects, Board members shared the view that economic growth would probably carry on in 2021 Q2 and Q3 at gradually slower quarterly paces than in Q1, yet mildly faster during the period overall than those anticipated in May. The evolution rendered likely the widening of the positive output gap at mid-2021 H2 to a visibly higher value than that indicated by the previous medium-term forecast, Board members showed.   At the same time, it implied the strong increase in the annual growth rate of economic activity in Q2 to a two-digit level significantly higher than the May forecast – amid the base effect associated with the sharp economic contraction in the same year-earlier period –, followed by its moderate decline in Q3.   It was observed that, according to recent developments in relevant indicators, private consumption had probably contributed most to the steep rise in the annual GDP dynamics in 2021 Q2, especially in the context of the unwinding of pent-up demand; however, gross fixed capital formation was also expected to have had a positive contribution.   Furthermore, net exports could have improved their contribution, as the significantly faster growth in exports of goods and services April through May, amid the strong revival of European economies, had outpaced that in imports. As a result, the year-on-year increase in trade deficit had posted a mild slowdown, while, under the additional impact of improvement in the primary and secondary income balances, the annual growth rate of the current account deficit had contracted markedly, remaining nevertheless above the average values seen in 2019 and 2020.   Looking at labour market, Board members noted the relatively fast improvement in labour market conditions as of spring, also compared to expectations, given the further rebound in economic activity in a large number of sectors. It was pointed out that the number of employees economy-wide had recovered at end-May 2021 most of the pandemic-induced losses, while the ILO unemployment rate had seen a steeper decline in June to reach 5.2 percent from 5.9 percent in January-February 2021.   The significant acceleration of the annual growth rate of wage earnings in April-May, on the back of developments in the private sector, had been however largely ascribable to the base effect associated with the enhanced recourse to furlough schemes during the state of emergency, some Board members noted. Besides, the annual dynamics of unit wage costs in industry had fallen deeper into negative territory during that period, in view of the much larger labour productivity growth, after the sizeable decline in the same year-earlier period.   Board members deemed that labour market looseness had probably seen a more pronounced abatement during the summer, citing stronger hiring intentions for Q3 revealed by surveys, as well as evidence of a recent rebound in recruitment to almost pre-pandemic levels. Certain market segments had even seen mismatches between labour demand and supply, as well as firms’ difficulties in recruiting skilled labour, with the potential to generate pressures on wages or increase employers’ recourse to workers from abroad, some Board members pointed out.   However, in the short run, uncertainties persisted about the epidemiological situation, given the resurgence in domestic infections and the marked slowdown in the pace of vaccination, as well as signs of a new pandemic wave in Europe and elsewhere, amid the spread of a more contagious Delta coronavirus variant.   Another source of uncertainty referred also to the ability of some businesses to remain viable after the cessation of government support programmes or in the context of a significant pick-up in some commodity prices. Over the longer time horizon, also relevant were deemed to be the expansion of automation and digitalisation domestically, as well as potential future actions designed to enhance the efficiency of public spending, which could affect labour market developments, apart from capping public sector wages.   Turning to financial market conditions, Board members showed the key interbank money market rates had remained in July at nearly 4-year lows touched in 2021 Q2, while yields on government securities had posted meagre increases in the first half of the month for shorter maturities and had seen steeper upward movements for longer maturities, before stabilising across the entire maturity spectrum.   The average lending rate on new business to non-bank clients had recorded a new decline in June, falling to a very low value from a historical perspective. In the near run, it would probably decrease further, under the influence of the downward trend of the IRCC, which had increased considerably at the beginning of 2021 Q3, but would slow down markedly in the last three months of 2021, some Board members underlined.   The EUR/RON exchange rate had remained, however, quasi-stable in the first part of July, and subsequently had experienced a gradual downward adjustment, mainly owing to seasonally-driven domestic developments. Board members were of the opinion that the interest rate differential also continued to be relevant, even amid its narrowing versus some markets in the region, following the policy rate hiking cycle initiated and recently consolidated by two central banks.   The economy’s external imbalance and other domestic economic fundamentals were however likely to induce risks to the future evolution of the leu exchange rate, implicitly to inflation, some Board members cautioned, especially in the event of a sudden change in the global market sentiment.   Board members observed that lending activity had continued to step up in June, inter alia, thanks to the relatively increased support of government programmes. Thus, the flow of leu-denominated loans to households had reached a new historical high, mainly on account of the peak in housing loans, while leu-denominated loans to non-financial corporations had posted a faster annual growth rate to 22.1 percent, i.e. the highest since January 2009.   Against that background, the annual dynamics of credit to the private sector had climbed to 11.2 percent from 10.1 percent in May, whereas the share of the leu-denominated component in total private sector credit had widened to 71.1 percent.   As for future macroeconomic developments, Board members discussed at length the anticipated inflation pattern, showing that it was again revised markedly upwards in the short term and to a smaller extent over the latter part of the projection horizon. Specifically, the annual inflation rate was expected to climb more sharply above the variation band of the target in 2021 H2 than anticipated previously, to 5.6 percent in December 2021 from 4.1 percent in the May forecast, and following the downward corrections in the first part of next year to decline and then remain marginally below the upper bound of the band, at 3.4 percent, above the 3.0 percent level forecasted previously.   The sizeable worsening of the short-term inflation outlook was further attributable to the adverse supply-side shocks, Board members repeatedly underscored, especially, in the current context, to the likely much higher increases in natural gas, electricity and fuel prices that had already occurred in July. Those hikes were seen adding around 1 percentage point to the annual inflation rate as early as the first month of 2021 H2 and were likely to amplify and protract the transitory inflationary impact of supply-side factors, the Board members pointed out, yet also to exert, contrariwise, significant disinflationary base effects in 2022, in addition to those associated with the rise in electricity prices in January 2021 and the advance in oil prices in 2021 H1.   Two-way influences over different time horizons, yet similar in terms of intensity to those forecasted previously, were expected to come from the uptrend in some international commodity prices, mostly for agri-food products, affecting core inflation in particular.   Board members assessed that the balance of supply-side risks to the inflation outlook remained, however, slightly tilted to the upside, at least in the short run. They cited bottlenecks in production and supply chains, along with hikes in prices of many commodities and in the cost of transport, fuelling inflation worldwide, as well as the possible increase in the pass-through of higher costs into prices, amid past losses incurred by firms and the unwinding of pent-up demand, but also possibly higher-than-expected agricultural output for certain crops in 2021.   Several Board members underlined that a potentially more sizeable and repeated pick-up in inflation rate under the impact of some upside risks materialising would lead to a stronger erosion of households’ real disposable income, with adverse effects on consumer demand and aggregate demand over a considerable horizon. At the same time however, also in the context of the already reopened excess aggregate demand, it could increase the capacity of supply-side shocks to affect medium-term inflation expectations, which required close monitoring of all developments, Board members agreed.   Moreover, underlying inflationary pressures would probably become more pronounced over the projection horizon than anticipated before, yet only gradually, Board members concluded. The major reason was the expected rise in excess aggregate demand at relatively higher levels, albeit at a somewhat slower pace, given its reopening already in 2021 Q1, as well as the likely robust growth of the economy in the years ahead, only marginally weaker than previously projected, in the context of disbursements of EU funds under the Next Generation EU programme, which would at least partly offset the contractionary impact of budget consolidation.   Over the policy-relevant horizon, underlying inflationary pressures could, however, be mitigated by the relative improvement in aggregate demand structure compared to the pre-pandemic period – through a larger contribution of investment to the detriment of private consumption, with implications also for the future performance of potential GDP – and by the decline well below pre-pandemic levels in unit labour cost dynamics, amid the still loose labour market and sharp labour productivity growth, some Board members deemed.   Slight inflationary effects, yet relatively more pronounced than in previous assessments, were expected, on the other hand, from non-energy import price dynamics, and in the near run from short-term inflation expectations and indirect effects of supply-side shocks. Against that backdrop, the annual adjusted CORE2 inflation rate was likely to pick up momentum in 2021 H2, and after a small fluctuation, it would stabilise at 3.4 percent – above 2.8 percent and 3.1 percent previously projected for December 2021 and the forecast horizon, respectively.   Looking at the future cyclical position of the economy, Board members noted that the economy was likely to expand at a much swifter pace this year than previously forecasted – mainly due to the first-quarter performance –, and in 2022 its growth, albeit moderating visibly, would remain robust, with only marginally slower quarterly rates than in the prior projection, comparable to those in pre-pandemic years. The evolution implied a somewhat slower rise in excess aggregate demand over the forecast horizon, yet on a slightly higher path than expected in May, even amid the new notably upward revision of potential GDP growth.   At the same time, private consumption was expected to be the major driver of economic growth in 2021-2022, with much higher dynamics this year than projected in May, attributable nonetheless mainly to the statistical carry-over effect and to that of the short-term action of previously pent-up consumer demand. Adjusted for these effects, the anticipated rise in private consumption over the forecast horizon was, however, below the 2016-2019 average, Board members observed. By contrast, gross fixed capital formation was foreseen to post markedly faster dynamics than the pre-pandemic average and, at the same time, significantly higher than projected in May, particularly for 2021.   That would imply a relatively larger contribution of this component to economic advance, amid the broader increase in public investment expenditures and their stimulative effect on private sector investment, financed by EU funds as well.   In turn, net exports were seen likely to reduce their contractionary impact in 2021 and 2022, yet much more modestly than expected in May, given the stronger pick-up in domestic absorption than that expected in external demand, implying higher imports, associated also with investment/reforms financed under the Next Generation EU programme and with increases in some international commodity prices. In that context, the worsening outlook of the current account deficit was deemed worrisome, as the external deficit was expected to follow a sharper uptrend as a share of GDP in 2021 and to see only a marginal correction in 2022, implying its higher growth above European standards over the projection horizon, which was likely to entail risks to inflation, but also to economic growth sustainability.   However, the evolution of the pandemic and of the associated containment measures posed, at least in the near run, heightened uncertainties and risks to the current medium-term macroeconomic outlook, Board members agreed, given the resumed growth in domestic infections and the marked slowdown in the pace of vaccination, as well as signs of a new pandemic wave in Europe and elsewhere, amid the quick spread of the more contagious Delta coronavirus variant.   The fiscal policy stance also remained a source of uncertainties and risks. Its degree of restrictiveness could change markedly over the forecast horizon, being difficult to anticipate given the unknowns about the magnitude, pace and instruments of the budget consolidation presumed to be carried out gradually over the medium term – a key process for economic stability, also in terms of the implications for the sovereign risk premium and financing costs, several Board members underlined.   Moreover, reference was made to the constraints stemming from the large volume of permanent expenditures and from the hikes in some commodity prices, as well as to the positive impact exerted on this year’s government revenues by a number of factors, including nominal GDP growth well above the budget assumption, which largely explained the clearly improved budget execution in the first half of this year.   At the same time, however, some members noted the European institutions’ recommendations in the context of the excessive deficit procedure setting forth a certain adjustment path in the 2021-2024 period, as well as a particular treatment of unanticipated revenues, also calling for the implementation of additional corrective measures.   Under the circumstances, Board members deemed that the coordinates of the upcoming budget revision and especially the budget consolidation strategy presumed to be prepared by autumn consistent with the said recommendations were particularly important in terms of the short- and medium-term characteristics of the fiscal policy. Several members were of the opinion that high uncertainties were further associated with the absorption rate of EU funds allocated to Romania via the Recovery and Resilience Facility, as well as of those under the new Multiannual Financial Framework 2021-2027.   They referred to the delay until this autumn in the EC approving the National Recovery and Resilience Plan, as well as to Romania’s institutional capacity and track record in that respect.   In the Board members’ opinion, the analysed context warranted leaving unchanged the NBR’s key interest rates, while preserving tight control over money market liquidity. Such a calibration of the monetary policy conduct aimed to preserve price stability over the medium term, in a manner conducive to achieving sustainable economic growth in the context of the fiscal consolidation process, while safeguarding financial stability. Moreover, it was deemed necessary to closely monitor 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 1.25 percent, while preserving tight control over money market liquidity; moreover, it decided to leave unchanged the deposit facility rate at 0.75 percent and the lending (Lombard) facility rate at 1.75 percent. Furthermore, the NBR Board decided to maintain the existing levels of minimum reserve requirement ratios on both leu- and foreign currency-denominated liabilities of credit institutions.   (Photo:https://www.bnr.ro/The-Board-of-Directors--1320-Mobile.aspx)