National Bank of Romania Increases Monetary Policy Rate to 3%

The Board of the National Bank of Romania, having convened for the meeting on 5 April 2022, established new decisions on monetary policy.

It seems that the assumptions on a possible raised key interest came true in the Romanian banking chapter. The high inflation rate, reaching in February 2022 an annual rate of 8.53%, prompt the National Bank of Romania to hike key interest rates up to 3% in April, as it did in February.

The NBR Board voted to raise the monetary policy rate to 3.00% per year from 2.50% per annum as of 6 April 2022, based on currently available data and assessments and the extremely high level of uncertainty. It also agreed to boost the loan (Lombard) facility rate to 4.00% per year from 3.50% per year, and the deposit facility rate to 2.00% per year from 1.50% per year, while maintaining tight control over money market liquidity. Furthermore, the NBR Board resolved to maintain the current minimum reserve requirement ratios on credit institutions’ liabilities denominated in leu and foreign currency.

Contrary to estimates, the annual inflation rate increased steadily in the first two months of 2022, rising to 8.35% in January and 8.53% in February from 8.19% in December 2021. Following the slower increase in electricity and natural gas prices, amid a base effect and extended price capping schemes, the exogenous CPI components had a disinflationary contribution overall, which outweighed the relatively more pronounced hike in fuel VFE prices, and administered prices.

The annual adjusted CORE2 inflation rate followed a faster-than-expected upward path in the first two months of 2022 Q1, going up to 5.2% in January and to 5.9% in February, from 4.7% in December 2021, mainly as a result of the step-up in broad-based increases in processed food prices. Therefore, the evolution of this component continues to reflect the effects of the surge in agri-food commodity prices and energy and transport costs, alongside the influences of persistent bottlenecks in production and supply chains, compounded by increasingly higher short-term inflation expectations, the resilience of demand in specific segments, as well as by the significant share of food items and imported goods in the CPI basket.

Economic activity continued to weaken more than expected in 2021 Q4, falling by 0.1% versus the previous quarter, but solely on the back of the marked deterioration in the performance of agriculture. The developments make it likely for excess aggregate demand to remain low during this period, in line with February expectations, given, among other things, the implications of the new revision of statistical data on economic growth in 2020 and 2021.

In turn, net exports made a slightly lower negative contribution to annual GDP dynamics, as the decrease in the change in imports of goods and services outpaced that of exports. Against this background, the yearly increase in the negative trade balance decelerated considerably as against Q3 due to the narrowing of the unfavourable differential between the dynamics of import prices and those of export prices. Conversely, the current account deficit widened in annual terms at a significantly faster pace, under the impact of the marked worsening of the secondary income balance, on account of a decrease in inflows of EU funds to the current version compared to the same year-earlier period.

The labour market has also witnessed mixed developments in the recent period. Thus, the number of employees economy-wide rose slightly in December 2021 and January 2022 to a record high. In contrast, the ILO unemployment rate climbed to 5.7% in December 2021 and remained unchanged in January and February 2022, above the historical low touched in the summer of 2019. However, the labour shortage reported by companies posted a faster increase from January through March 2022 while remaining considerably below its peak. The hiring intentions for the following three months, as shown by the DG-ECFIN survey, increased in January-February, but saw a moderate downward adjustment in March, amid the high uncertainties generated by Russia’s invasion of Ukraine and the retaliatory international sanctions.

Looking at the financial market, the central interbank money market rates witnessed a faster pick-up in February and March 2022, reaching nine-year highs following the new monetary policy rate hike and amid the pronounced tightening of liquidity conditions and expectations of a further increase in the key rate. Yields on government securities saw their generally upward path steepen as well, posting marked rises in the early days of March, only partly corrected afterwards, given the abrupt deterioration of financial investor sentiment, especially vis-à-vis markets in the region, following the outbreak of the war in Ukraine and the imposition of international sanctions.

The annual growth rate of credit to the private sector climbed further into the double-digit territory during the first two months of 2022, reaching 15.8% in February and 15.49% over the period, from 14.31% in 2021 Q4. This was mainly ascribable to a renewed step-up in the solid dynamics of the leu-denominated component – to a period average of 19.8 % –to which added the faster pace of increase of forex loans. In February, the share of leu-denominated loans in credit to the private sector widened to 72.5%.

According to current assessments, the annual inflation rate is expected to rise somewhat more steeply in the coming months than anticipated in February, under supply-side shocks.

Behind the renewed worsening of the near-term inflation outlook stand the much higher increases expected for fuel prices, especially for processed food prices, mainly due to the more substantial advance in crude oil and agri-food commodity prices, amid the war in Ukraine and the international sanctions in place. The inflationary effects thus exerted are 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.

Uncertainties and risks surrounding medium-term prospects increase, nevertheless, considerably owing to the war in Ukraine and the associated sanctions, which pose a new sizeable supply-side shock globally. This exerts divergent effects on inflation and economic activity domestically, mainly by compounding the energy crisis and the production chain bottlenecks, but also via other channels, such as the economy and inflation dynamics in Europe/worldwide, consumer and investor confidence, as well as risk perception towards the region, with an impact on financing costs.

A significant source of uncertainties and risks also remains the absorption of EU funds – especially those under the Next Generation EU programme – conditional on fulfilling strict milestones and targets for implementing the approved projects. At the same time, the improvement in the epidemiological situation on the domestic front led to the end of the state of alert in the first 10-day period of March 2022 and the lifting of all mobility restrictions, with favourable effects on economic activity.

Moreover, uncertainties and risks are associated with the future fiscal policy stance, given the requirement for further fiscal consolidation in line with the commitments under the excessive deficit procedure, yet in a challenging economic and social environment domestically and globally, marked by the implications of the war in Ukraine and of the sanctions imposed on Russia, but also by the tightening trend of financing conditions.

The NBR Board decisions aim to anchor inflation expectations over the medium term, as well as to foster saving through higher bank rates, to bring back the annual inflation rate in line with the 2.5% ±1 percentage point flat target on a lasting basis, in a manner conducive to achieving sustainable economic growth in the context of the fiscal consolidation process.

With high inflation, a lingering crisis, and dwindling international reserves, Romania will need to undertake an immediate economic stimulus plan. Furthermore, as Nomura Bank predicted in November 2021, Romania is one of the four countries at risk of a currency crisis.

Given the lower number of foreign investors, Romania may suffer a more serious economic and financial crisis than other nations in the region if proper economic and financial management is not performed.