National Bank of Romania cut the main interest rate by 0.25 percentage points

The National Bank of Romania has decided to cut its reference interest rate by a quarter of a percentage point. More specifically, the NBR’s Council, meeting in today’s session, decided to lower the monetary policy interest rate to 6.75% per annum from 7% per annum, starting from July 8, 2024, to lower the interest rate on the lending facility (Lombard) to 7.75% from 8%, and the interest rate on the deposit facility to 5.75% from 6%, as well as to maintain the current levels of the minimum reserve requirements for credit institutions’ liabilities in lei and in foreign currency.

The NBR’s cut still keeps the benchmark interest rate well away from the inflation rate, which will most likely fall below 5% in June, but it is a signal that the National Bank is ready for more cuts this year. The next moves, such as the one in August, will depend on the inflation outturn in July, when the minimum wage was raised and some taxes, such as excise duty on fuel, were increased.

According to the NBR release, the annual inflation rate accelerated its decline in the first two months of Q2 2024, falling to 5.12% in May, below the forecast level, from 6.61% in March, mainly due to the substantial cheapening of energy, especially natural gas, under the influence of legislative changes implemented since April, as well as the continued decline in food price dynamics.

The annual adjusted CORE2 annual inflation rate continued to decline gradually in line with forecasts, easing to 6.3% in May from 7.1% in March 2024. The deceleration continued to be driven by disinflationary base effects and corrections in agri-food commodity prices. Additional influences stemmed from a decline in import price dynamics and a return to a slightly downward trend in short-term inflationary expectations. In the opposite direction, further increases in unit labour costs in the first months of this year, at least partly passed through to the prices of some goods and services, also on the back of robust and strongly growing consumer demand in April, acted moderately.

The annual inflation rate calculated on the basis of the harmonized index of consumer prices (HICP – the inflation indicator for the EU Member States) fell to 5.8 percent in May 2024, from 6.7% in March 2024. At the same time, the average annual CPI inflation rate and the average annual HICP inflation rate declined to 7.6% in May, from 8.5% and 8.3%, respectively, in March 2024.

Economic activity expanded 0.4% in the first quarter of 2024, less than anticipated, after compressing 0.6% in the fourth quarter of 2023, so that the aggregate demand surplus likely continued to narrow in the interval, contrary to expectations. At the same time, compared with the same period a year earlier, GDP growth slowed significantly in the first quarter of 2024, to 0.1%, from 3% in the previous three months. The decline this time was mainly driven by gross fixed capital formation, whose annual momentum declined particularly sharply from the very high double-digit level reached in the fourth quarter of 2023, while household consumption continued to accelerate its growth in annual terms.

Net export developments increased their contractionary influence in the first quarter of 2024, amid a slight widening of the gap between the positive change in the volume of imports of goods and services and the positive change in the volume of exports, which remained in negative territory. The trade balance deficit, however, maintained its steady annual dynamics, while the current account deficit narrowed considerably compared with the previous quarter, given also the strong acceleration in the growth of the surplus of the secondary income balance in this interval, mainly on account of inflows of European funds of a current account nature.

The latest data and analysis point to a significant growth of the economy in quarter-on-quarter terms in the second quarter and visibly stronger than previously anticipated, implying a notable increase in GDP advance relative to the same period last year.

Thus, in April 2024, the annual momentum in retail sales and motor vehicle sales recorded large jumps relative to the Q1 2024 averages, industrial production rebounded strongly, and the pace of construction volume picked up again to double-digit levels after falling to a sizable negative value in the first three months of the year as a whole. The annual change in imports of goods and services, however, widened its positive differential with exports, while the latter increased relatively more markedly in April. As a result, the trade deficit accelerated sharply in annual terms and the current account deficit doubled compared to the same period of the previous year, also against the background of a deterioration in the balance of primary and secondary income.

In the labour market, the number of persons employed in the economy resumed its monthly growth in April at a brisk pace, while the BIM unemployment rate increased only slightly in April-May to 5.4%, remaining below the average level of 5.6% recorded in the last two quarters of the previous year. The double-digit annual dynamics of nominal gross wages continued to increase over the first three months of the year as a whole and held steady in April, while those of unit labor costs in industry remained at a particularly high level in Q1 2024, before declining sharply in April, but mainly on account of a calendar effect. At the same time, hiring intentions over the very short time horizon strengthened their upward trend in the second quarter as a whole, even in the face of a sizeable decline in June, and the labor shortage reported by companies recorded a further quarterly increase, as indicated by the latest surveys.

The main interbank money market quotes extended their linear trend in May and subsequently recorded small declines. Long-term government bond yields experienced a moderate downward adjustment in the middle of the second quarter, but rose and then remained at the higher levels since April, including in the context of fluctuations in investors’ expectations regarding the Fed’s interest rate outlook and political developments in Europe, which are likely to lead to changes in international financial market sentiment and risk perceptions associated with the region. Against this backdrop, the leu/euro exchange rate remained at the higher level in May June and returned to it in the second part of April.

The annual dynamics of credit granted to the private sector increased to 5.8% in April, after falling to 4.7% in March, and in May it remained relatively constant at 5.7%, as the growth of the lei component continued to accelerate during this period, while the pace of the foreign currency component returned to a slightly upward but fluctuating trend. Against this backdrop, the share of the lei component in credit to the private sector declined to 68.8% in May from 68.9% in March 2024.

According to the current assessment, annual inflation is projected to continue to decline in the months ahead on a significantly lower path than projected in the May 2024 medium-term forecast, mainly on the back of base effects and legislative changes in the energy sector, as well as decelerating import price growth and a gradual downward adjustment of inflation expectations in the near term.

Heightened uncertainties and risks stem from the future conduct of fiscal and revenue policy, given, on the one hand, the budgetary execution in the first five months of the year, public sector wage dynamics and the full impact of the new pension law, and, on the other hand, the fiscal measures that may be implemented in the outlook for further fiscal consolidation, including in the context of the excessive deficit procedure and conditionality attached to other agreements with the EC. Labor market conditions and wage dynamics in the economy also remain a source of significant uncertainties and risks. At the same time, significant uncertainties are associated with the presumed impact on gas and electricity prices of recent legislative changes, as well as with oil price developments.

Uncertainties and risks to the outlook for economic activity, and thus for medium-term inflation developments, continue to be generated by the war in Ukraine and the conflict in the Middle East, as well as by economic developments in Europe, particularly in Germany. At the same time, the absorption of EU funds, mainly those related to the Next Generation EU program, is conditional on the achievement of strict targets and benchmarks. It is, however, essential to achieve the necessary structural reforms, including the energy transition, but also to counterbalance, at least partially, the contractionary effects of geopolitical conflicts. The outlook for the conduct of the monetary policies of the ECB and the Fed, as well as the attitude of the central banks in the region, are also relevant.

Taking into account the latest available data and the prospect of a continued decline in the annual inflation rate in the coming months on a significantly lower path than previously anticipated, but also in the context of still high uncertainties, the Governing Council of the NBR decided, in its meeting of today, July 5, 2024, to reduce the monetary policy interest rate to 6.75% per annum, from 7% per annum, starting from July 8, 2024. It was also decided to reduce the interest rate on the lending facility (Lombard) to 7.75% from 8% and to reduce the interest rate on the deposit facility to 5.75% from 6%.

The Board of Directors of the NBR also decided to maintain the current levels of the minimum reserve ratios for credit institutions’ liabilities in lei and in foreign currency. The decisions of the Board of Directors of the NBR aim at ensuring and maintaining price stability in the medium term, in a manner that contributes to the achievement of sustainable economic growth. The Governing Council reiterates that, in the current context, the balanced macroeconomic policy mix and the implementation of structural reforms, including through the use of European funds that stimulate the long-term growth potential, are essential for macroeconomic stability and the strengthening of the Romanian economy’s capacity to face adverse developments.