CEE: Romania
NBR goes tighter but more will be needed soon
- NBR keeps monetary policy rate unchanged at 1.75 % but narrows the interest rate corridor
- September inflation is driven by volatile food prices, the monetary policy relevant core inflation increased only moderately.
- Strong economic growth and tight labor market conditions will require the NBR to act soon.
The National Bank of Romania (NBR) has kept its monetary policy rate unchanged at 1.75 %. By narrowing the corridor around the monetary policy rate from +/- 1.25 to +/- 1 %-points the NBR continued its gradual monetary policy normalization. The deposit facility rate was raised to 0.75 % while the lending facility rate was lowered to 2.75 %. The NBR’s interest rate corridor bounds overnight interbank rates, which are highly correlated with longer maturity interbank rates. The 3 months ROBOR, as the main reference interbank rate, increased by more than 80 basis points since mid-September, currently trading above 1.6 % (Figure 1 - see pdf).
Since August 2005 the NBR is following an inflation targeting framework. Analyzing inflation and inflation expectations is, therefore, crucial to understand the NBR’s medium-term rate outlook. Inflation is still below the NBR’s target of 2.5 % but within its target band of +/- 1 %-point. Inflation based on the national CPI reached 1.77 % in September after 1.15 % in August. Based on the harmonized consumer price index (HICP, Eurostat), inflation is still below the NBR’s lower threshold, nevertheless, showing the same dynamic with a substantial increase from 0.62 % in August to 1.36 % in September. The rise in inflation was not driven by the monetary policy relevant core inflation, which is most reflective of the underlying macroeconomic development, but by a 3.6 % (y/y) rise in unprocessed food prices, which contributed 0.6 %-points to HICP headline inflation. HICP core inflation (HICP excluding unprocessed food and energy) accelerated moderately from 0.8 % in August to 1.0 % in September. The NBR’s monetary policy relevant core inflation measure, labelled CORE2, (CPI excluding administered prices, volatile prices, tobacco products and alcoholic beverages) shows a similar dynamic with an increase of 0.2 %-points reaching 1.8 % in September. Based on the latest NBR’s macroeconomic forecasts from November, inflation is projected to reach the NBR’s target as early as Q4 2017 (2.7 %) and increases further to 3.2 % by the end of 2018 and 3.1 % in Q3 2019. Accelerating inflation is also well in line with survey based inflation expectations which increased markedly in the last two months (Figure 2 - see pdf).
The Romanian economy is booming with real GDP growth at 5.9 % (y/y) in Q2 2017 and a low unemployment rate of 5 % in September. Evidence of a tightening labor market is further given by strong growth in gross wages of above 15 % (y/y, average January-September), even though wage growth in the public sector is stronger than in industry (Figure 3 - see pdf). This scenario poses inflationary pressure, mainly on core inflation, which is further supported by a positive output gap. Decomposing quarterly GDP into a trend and cyclical component by applying the Hodrick-Prescott filter results in a positive output gap of 2.1 % for the first two quarters of 2017. The NBR comes to an output gap estimate of 2.4 % (November Inflation Report). Moreover, they expect the output gap to grow further reaching 3.6 % in Q1 2018 and 3.8 % in Q1 2019 *). Based on coefficient estimates from a hybrid New-Keynesian Phillips Curve (NKPC) the NBR’s output gap projection would result in an additional increase in core inflation at constant taxes at 0.9 % (y/y) until Q1 2019. The uncertainty from the recent weakening of the relationship between the domestic output gap and core inflation (flattening of the NKPC) results in a range of the effect between 0.5 and 1.0 % (y/y) if the lowest and highest coefficient estimates are used. The NBR’s CORE2 inflation excluding the direct effects of VAT was 2.0 % (y/y) in September and 1.5 % (y/y) in Q2 2017. Hence, given the expanding output gap and the dynamics in core inflation further action by the NBR will be needed to achieve its inflation target over the medium term.
CEE: Serbia
- Inflation has been well anchored and growth picked up in Q3 while the real yield in Serbia is already very low.
At the monetary policy meeting that took place last on Thursday 9th November, the executive board of the National Bank of Serbia (NBS) decided to keep the key policy rate on hold at 3.5 %. Previously, the NBS had lowered the policy rate twice this year by 25 basis points in September and October. The executive boards assessed that inflationary pressures remain low. In September, the inflation rate was 3.2 % (y/y) and lower than previously expected. The drought effects on food prices were weaker than expected. In addition, domestic inflation expectations seem to adjust to a lower level (Figure 4 - see pfd).
The real, inflation-adjusted interest rate has also reached a low (< 1 % on average) this year. The NBS expects inflation to continue moving within the target tolerance band (3.0 % +/- 1.5 percentage points) in the coming months and to be at a lower level in H1 2018 due to high base effects from the prices of petroleum and other products that underwent one-off price hikes early in this year. The expected rise in the prices of non-processed agricultural products and aggregate demand will act in the opposite direction.
Growth firmed in the third quarter of 2017. Real GDP increased by 2.1 % (y/y) after expanding on average by 1.2 % in H1 2017. Industrial production including manufacturing picked up rising by 6.3 and 7.3 % (y/y) on average in Q3. Monthly retail sales increased by 3.7 % during the third quarter.
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*) Besides, a measure of economic slack (output gap) and inflation expectations (DG ECFIN survey) the hybrid NKPC incorporates lagged inflation to accout for a fraction of producers whose price setting behavior ist based on past price developements (see Gali, J. and Gerler, M., 1999, Inflation Dynamics. A Structural Econometric Approach, Journal of Monetary Economics, 44(2), 195-222). The real effective exchange rate is considered as an additional determinant of inflation as a measure of imported inflation.