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July 7, 2022
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Economy Romanian News

Romania’s Central Bank Warns about Risks to Economy

According to the Minute of the Board’s meeting on May 10, the Board of Romania’s Central Bank reasoned that if it intervened more strongly in the market through higher interest rates and a more active sterilization policy, the “effect would be devastating for the economy.” The last increase of the monetary policy rate was on May 10, when it reached 3.75pc.

Looking at recent inflation developments, Board members noted that the new increase in the annual inflation rate in March 2022 to 10.15% from 8.53% in February was driven by a more robust pick-up in processed food and fuel prices as a result of the sharp rise in agri-food commodity and crude oil prices, which coincided with the outbreak of the war in Ukraine and the imposition of international sanctions. The annual inflation rate had thus increased significantly, and faster than expected, in 2022 Q1, from 8.19% in December 2021.

Nevertheless, it was also emphasized that any potential central bank attempt to mitigate the powerful direct and indirect inflationary effects of adverse supply-side shocks would be ineffective and counterproductive, given the significant economic activity and employment losses over the longer term.

Members also noted that the EUR/RON exchange rate remained relatively stable in April, which bodes well for inflation and confidence in the domestic currency. However, risks to exchange rate developments were on the rise, with potentially damaging consequences for external vulnerability indicators, according to Board members. They referred to the size of the external imbalance and the uncertainties associated with budget consolidation during the Ukraine conflict, as well as the Fed’s and ECB’s prospective monetary policy stances, as well as the significant local interest rate differential vis-à-vis countries in the region, given the ongoing rapid increases in critical rates by central banks in Czechia, Poland, and Hungary.

Under the circumstances (high energy and food prices, disrupted supply chains), the annual adjusted CORE2 inflation rate would most likely continue to rise until the end of 2022, albeit at a much slower pace in H2, rising to 10.9% in December, well above the previously anticipated level, board members predicted.

It would take a more pronounced downward path than anticipated earlier, but it would remain at 4.2% at the end of the projection horizon, compared to the February forecast of 3.2%.

Looking ahead to the economy’s cyclical position, Board members observed that, after reaching very high dynamics from a historical perspective in 2021, but slightly lower than expected, economic growth was expected to decelerate significantly in 2022-2023, and substantially more pronounced than in previous forecasts. This was due to the impact of the war in Ukraine and the sanctions imposed, which would likely peak in 2022 and would only be partially offset by the effects of EU funds absorption under the Next Generation EU instrument. The evolution implied many lower-than-previously-estimated values of excess aggregate demand, gradually shrinking as of 2022 Q2 and approaching zero by the end of the projection horizon, despite a significant downward adjustment of the potential market.

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