The National Bank of Romania’s Strategic Moves Amid Economic Challenges
This summer, the National Bank of Romania (BNR) seized a unique opportunity to implement two minor reductions in the key interest rate, as a precaution for the upcoming autumn, which may present considerable economic difficulties, including potential capital outflows, according to Governor Mugur Isărescu. He emphasizes that, despite the declining inflation rates, it is premature to consider a monetary easing cycle, especially given the high budget deficit.
Analysts are divided on the BNR’s future actions, reflecting a range of opinions regarding the central bank’s next steps.
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Current Economic Context
The BNR has recently lowered the monetary policy interest rate for the first time in three and a half years, reducing it from 7% to 6.5% in July and August, making it the second-highest rate in the region after Hungary.
Despite these two adjustments, Isărescu asserts that they do not indicate the beginning of a trend toward interest rate cuts or a shift in monetary policy. In real terms, with inflation at 4.9% annually in June, the key interest rate remains positively real, contrasting sharply with last year’s negative real rates when inflation was in double digits. Furthermore, both market rates and deposit rates, calculated retrospectively, are now real positive, a situation not seen in the past seven years.
In fact, across the region, key interest rates are above inflation rates, with Romania leading this trend: the Czech Republic has an inflation rate of 2% and a key rate of 4.5%, Poland has 2.6% inflation with a 5.75% interest rate, and Hungary shows an inflation rate of 3.7% and a key rate of 6.75%.
Future Implications
Isărescu notes that the BNR’s policy appears more restrictive now than it was last year and will likely become even more so as inflation decreases, unless interest rates are also lowered. He further mentions that the bank did not want to maintain elevated interest rates at 7% for an extended period.
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Autumn Opportunities: The Impact of Declining Inflation
As autumn approaches, analysts have identified what they describe as a significant window of opportunity arising from the faster-than-expected decrease in inflation observed in recent months. Isărescu emphasizes the necessity of not maintaining a high monetary policy rate during this season, especially when it may become more challenging to make rate reduction decisions due to potential disruptive factors. He warns, “Any moment could see a reversal in capital movements.”
Market Volatility and Central Bank Tools
Highlighting the volatility of financial markets, Isărescu references a recent, albeit brief, decline in stock indices, particularly in Asia. In light of such adverse scenarios, he reassures that the National Bank of Romania (BNR) possesses various tools to manage the situation effectively. These include utilizing foreign currency reserves to stabilize exchange rates—deemed by the BNR as a critical anchor of stability—and sterilizing interbank liquidity at interest rates exceeding those of the deposit facility, a move that could enhance the attractiveness of the national currency, the leu.
Inflation Trends and Economic Forecasts
Moreover, the ongoing decrease in inflation is expected to contribute to a relative tightening of monetary policy, which is likely to deter capital outflows. Current projections suggest that inflation may fall to around 4% by the end of the year, down from the 4.9% anticipated in the central bank’s May report. This decline is primarily attributed to lower energy prices and a slower increase in food costs.
Consumer Confidence and Economic Factors
In a report released following the recent monetary policy decision, ING Bank points out that the favorable inflation developments are not solely attributable to factors within the central bank’s control. Instead, they are influenced significantly by international food price fluctuations and legislative interventions concerning energy pricing. Economists Valentin Tătaru and Ștefan Posea from ING indicate that demand pressures in the economy remain high, particularly when examining double-digit wage growth, credit activity, and robust retail sales.
Future Monetary Policy Considerations
According to ING, the economic fundamentals and associated risks are expected to play a more prominent role in shaping monetary policy optimization in the upcoming period than they did during the latest decision. Theoretically, if BNR were to focus solely on inflation trends, there would be more room for interest rate cuts in the October meeting, particularly if inflation continues its downward trajectory as projected. However, ING anticipates that the central bank may opt for a pause in its adjustments this time.
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Monetary Policy Outlook: BCR’s Predictions and Fiscal Challenges
The current economic landscape suggests a significant trend towards disinflation, according to analysts at BCR. They anticipate that the central bank may implement two additional interest rate cuts this year, potentially lowering the rate to 6%, provided inflation does not exceed expectations.
Analysts at BCR support the National Bank of Romania’s (BNR) inflation forecast, viewing Governor Mugur Isărescu’s cautious approach as conducive to further monetary easing. “The governor believes that the existing monetary policy stance is relatively robust,” state BCR economists Ciprian Dascălu and Vlad Ioniță. “By reducing the interest rate, the central bank has alleviated some of the restrictive elements of its policy.” They note that BNR remains data-dependent and maintains certain policy restrictions to counteract an expansive fiscal policy.
As inflation is predicted to continue its downward trend, the real interest rate is expected to rise, indicating a tightening of monetary policy. However, for BNR to implement the two anticipated rate cuts, a favorable external environment and a stable political climate prior to the elections are crucial factors, according to BCR analysts.
Fiscal Deficits and Economic Stimulus
Isărescu has also highlighted the precarious fiscal situation, noting that the budget deficit reached 3.5% of GDP by mid-year, while the target for the entire year is 5%. This situation is further complicated by the upcoming increase in pension payments starting next month. “The budget deficit is hindering any potential interest rate reductions,” he explains, emphasizing that “we are not overly stimulating the economy; fiscal policy is doing enough in that regard.”
The resolution of the fiscal issues may only come after the elections, according to the governor, who points out that current projections are based on existing data and do not account for potential tax increases in the following year. The inflation forecast for 2025 is set at 3.4% by year-end.
Government’s Role in Fiscal Policy
Regarding the necessary measures to address the fiscal challenges, Isărescu has directed inquiries to the Minister of Finance, extending his best wishes for securing funds for pensions. Nonetheless, he expresses the opinion that the government should consider eliminating certain tax benefits granted to specific groups.
