The National Bank of Romania (BNR) said it revised upward the inflation outlook over the next two years, meaning both the magnitude of the “transitory” inflation this year and the medium-term inflation seen over two years (3% y/y previously), but it still refrained from joining the interest rate normalisation trend.

At its August 6 monetary board meeting, the BNR maintained the refinancing rate at 1.25%, “in light of the elevated uncertainty” and also kept the interest rates corridor at +/-0.5pp.

The updated inflation scenario shows a higher path of the projected annual inflation rate over the next two years, with the indicator being again revised considerably upwards in the short term and to a lower extent in the latter part of the projection horizon, BNR said.

The revised quarterly Inflation Report will be published on August 9, but the note issued by the BNR along with the monetary policy decision on August 6 shows that the central bank expects more clarity from the government before taking steps that cannot be reversed quickly. More precisely, the rate hike needed to address the rising inflation (3.94% as of June, versus BNR’s 3.5% expectations) should be correlated with the fiscal consolidation path that Prime Minister and acting Finance Minister Florin Citu has not yet embarked upon. Other sources of uncertainty are pointed out by the BNR as well.

On the other hand, the big picture sketched by the BNR indicates elements supportive of a rate hike: the dynamics of the economic recovery and the inflationary drivers. The annual adjusted CORE2 inflation rate stopped its downward trend in 2021 Q2, a little earlier than anticipated, moving up to 2.9% in June from 2.8% in March 2021. Domestic demand is confirmed to be the sole driver of the economic upturn, in the context of the strong re-acceleration of private consumption. The current account deficit in 2021 Q1 posted the largest widening in annual terms in the past 14 quarters. The annual growth rate of credit to the private sector continued to pick up in June, reaching 11.2%, from 10.1% in May.

All these elements slightly increased general expectations for a rate hike in the short-term. 

The monetary policy rate decisions aim to preserve price stability “in a manner conducive to achieving sustainable economic growth” in the context of the fiscal consolidation process while safeguarding financial stability, said the BNR.

There are two sources of uncertainty, namely the evolution of the pandemic and the government’s policies in the areas of fiscal consolidation and absorption of European funds.

The BNR also lists the government’s ongoing budget revision, the medium-term fiscal consolidation plan (expected by the European Commission this October) and the fate of the Resilience Plan as uncertainties relevant to monetary policy decisions.

While the health situation indeed generates risks supporting a more conservative approach in the interest rates normalisation process, the fiscal policies have not justified the BNR’s caution so far, yet they have the potential to do so.

Namely, amid expectations for a 6.2%-of-GDP budget deficit this year expressed by the CFA analysts recently, Citu has not yet announced plans to revise downward the 7.16% deficit target set under much harsher economic conditions at the beginning of the year.