Interest Rate Decrease by the National Bank of Romania
The Board of Directors of the National Bank of Romania has decided on Friday, July 5, 2024, to decrease the policy interest rate to 6.75% per year, from 7% per year, starting from July 8, 2024. The interest rate for the Lombard lending facility has been decreased to 7.75%, from 8% per year, and the interest rate for the deposit facility to 5.75% per year, from 6% per year.
In making this decision, the members of the Board of Directors of the NBR have taken into consideration several factors including the inflation rate, economic growth, Gross Domestic Product growth, certain financial indicators, as well as risks and uncertainties for the upcoming period.
Regarding the annual inflation rate, the members of the Board of Directors of the NBR have observed that it has accelerated its decrease in the first two months of the second quarter of 2024, dropping to 5.12% in May, below the projected level, mainly due to cheaper…
Decrease in Energy Prices and Inflation Rate
In the past months, there has been a substantial decrease in energy prices, especially natural gas, due to legislative changes implemented starting in April. This decrease is also influenced by the continuing decline in food prices dynamics. According to a press release issued by the National Bank of Romania, the annual core inflation rate has gradually decreased to 6.3% in May, from 7.1% in March 2024. This deceleration was driven by disinflationary base effects and corrections in agri-food commodity prices.
Furthermore, the annual inflation rate calculated based on the harmonized index of consumer prices (HICP – EU member states inflation indicator) dropped to 5.8% in May 2024. The average annual inflation rate based on the Consumer Price Index (CPI) and the average annual inflation rate calculated using HICP also decreased to 7.6% in May. Despite these decreases in inflation rates, economic activity has grown by 0.4% in the first quarter of 2024.
Challenges in the Economy
Despite expectations, the economy faced a 0.6% decrease in the fourth quarter of 2023, leading to a continued contraction of aggregate demand surplus during this period. Moreover, compared to the same period last year, the GDP growth rate significantly dropped in the first quarter of 2024, reaching only 0.1% from 3% in the previous three months. This decline was mainly driven by a sharp decrease in gross fixed capital formation, which experienced a significant annual decline from the high double-digit levels reached in the fourth quarter of 2023, while household consumption continued to accelerate its growth on an annual basis.
Top decision-makers at the central bank argue that the evolution of net exports has increased its contractionary impact in the first quarter of 2024, due to a slight widening of the gap between the positive variation in the volume of imports of goods and services and that of exports.
Positive Trends in the Economy
In the latest report, it was noted that the economy has shown positive signs of growth despite remaining in negative territory. Although the trade balance deficit has been maintained, the current account deficit has decreased significantly compared to the previous quarter.
The most recent data and analysis indicate a significant increase in the economy on a quarterly basis in the second quarter, surpassing previous expectations and suggesting a notable growth in GDP compared to the same period last year.
Strong Growth in Various Sectors
In April 2024, there were significant jumps in the annual dynamics of retail sales and automotive sales compared to the averages of the first quarter of 2024. Industrial production has seen a strong revival, and the pace of construction work has once again reached double-digit levels after a considerable negative decline in the first three months of the year.
The annual variation in imports of goods and services has also shown positive trends, indicating a potential for further growth in the coming months.
Trade Deficit and Labor Market Update
In April, the trade deficit widened significantly compared to exports, with a more pronounced increase than in previous months. As a result, the trade deficit accelerated its growth on an annual basis, and the current account deficit doubled compared to the same period last year, due to the deterioration of primary and secondary income balances. On the labor market, the number of employees in the economy resumed monthly growth in April at a fast pace, while the unemployment rate increased only slightly in April-May, reaching 5.4%, remaining below the average level of 5.6% recorded in the last two quarters of the previous year.
Monetary Market Trends
According to the central bank, the main interbank market rates continued their linear trend in May and subsequently recorded small declines. Long-term government bond yields experienced a downward adjustment in response to market conditions.
Financial Market Trends in April and May
Financial markets experienced moderate volatility in the second quarter, with fluctuations in investor expectations regarding the Federal Reserve interest rate and political events in Europe impacting market sentiment and risk perception. Despite this, exchange rates remained relatively stable, with the leu/euro rate remaining at higher levels throughout April and May.
Credit Dynamics and Private Sector Growth
In April, annual credit growth to the private sector increased to 5.8% after a decrease to 4.7% in March. This growth remained relatively stable at 5.7% in May, driven by growth in domestic currency loans and a slightly upward trajectory in foreign currency loans. The central bank’s report highlights the continued acceleration of credit growth in local currency and the fluctuating trend in foreign currency loans.
Decrease in Private Sector Credit and Inflation Rate
In May, the share of the component in lei in the credit granted to the private sector decreased to 68.8%, down from 68.9% in March 2024. According to current assessments, the annual inflation rate will continue to decline in the coming months on a significantly lower trajectory than highlighted in the medium-term forecast from May 2024, mainly under the influence of base effects and legislative changes in the energy sector, as well as against the backdrop of decelerating import price growth and the gradual downward adjustment of short-term inflation expectations.
Uncertainties and Risks in Fiscal and Revenue Policies
Regarding the increased uncertainties and risks arising from future fiscal and revenue policy conduct, the National Bank of Romania indicates that among these are the poor budget execution in the first five months of the year, the dynamics of public sector salaries, and the full impact of the new pension law, as well as the non-implementation of fiscal-budgetary measures.
Challenges for Budget Consolidation
Despite being in an excessive deficit procedure, there are still uncertainties and significant risks that need to be considered. One major source of uncertainty is the labor market conditions and wage dynamics in the economy. Additionally, there are significant uncertainties associated with the presumed impact on natural gas and electricity prices due to recent legislative changes, as well as the evolution of oil prices.
Uncertainties and risks regarding the economic outlook, and implicitly the medium-term evolution of inflation, continue to be generated by the war in Ukraine and the conflict in the Middle East, as well as economic developments in Europe, particularly in Germany. Moreover, the absorption of European funds, especially those related to the Next Generation EU program, is conditioned by strict targets and milestones. However, it is essential for implementing reforms.
The Importance of a Balanced Mix of Policies for Economic Stability
The Board of Directors of the National Bank of Romania emphasizes the need for a balanced mix of macroeconomic policies and structural reforms to maintain economic stability. This is essential not only for the energy transition but also to counteract, at least partially, the contractionary effects of geopolitical conflicts.
In the current context, it is crucial to implement reforms that will utilize European funds to stimulate long-term growth potential. This will help strengthen the Romanian economy’s capacity to withstand adverse developments. The next meeting of the Board of Directors dedicated to monetary policy is scheduled for August 7, 2024.
