bne IntelliNews – ING: the caution of the former Romanian central bank is bearing fruit
By not pushing its key rate close to zero, the National Bank of Romania (NBR) now has a little more time to act than its regional peers. While the risks of rate hikes in 2021 have increased, we still believe that the NBR will try to delay these measures until 2022. Inflation will be a headache, but tighter liquidity management should be the problem. initial tool of choice.
With its latest revised inflation forecast clearly outside its target range, it looks like the National Bank of Romania could be the latest to join the regional chorus calling for tighter policy. That said, there are other factors to consider.
All CE4 central banks except the NBR have noted with varying degrees of conviction that they envision a tightening in 2021 (Czechia and Hungary) or mid-2022 at the latest (Poland). But the NBR is not there yet and it could choose to stay behind the curve for longer. Why?
We believe that while the NBR will not remain satisfied with rising inflation, the peculiarities of Romanian inflation will call for a different approach from that of its regional peers. – where “standard” rate hikes are mainly considered.
Core vs title
Headline inflation is indeed perceived by the NBR at 4.1% in December 2021, well above the initial estimate of 3.4% and the upper limit of 3.5% of the target range of inflation of 2.5% ± 1 ppt. However, core inflation has only been revised slightly upwards, from 0.1 to 0.3 pt for the entire forecast horizon, and is generally considered stable just below 3.0%. until the end of 2022.
Not in my garden
The surge in headline inflation is repeatedly attributed mainly to “factors beyond the control of monetary policy”, in particular energy.
More time to buy
We now take a look at the behavior and statements of the NBR during the pandemic. The Bank stressed the need for it to preserve its political room for maneuver and has done so. While all other affected central banks in the region cut their interest rates close to zero, the NBR kept a relatively generous interest rate differential, halting rate cuts at 1.25% despite most of the market forecasts calling for rates below 1%. This now allows for a wait-and-see approach, with inflation at the door. It also reinforces the NBR’s growing tendency to “look through” inflation cycles.
What would a rate hike mean, given the nature of the current spike in inflation?
In our opinion, the main points to consider are:
Is the economy overheating? Until today, the answer was a simple “no”. The economy is expected to have reached pre-crisis levels by the end of 2Q21 / early 3Q21. With today’s GDP figures, we know that we are already above pre-crisis levels. However, despite good figures, the economic recovery is still fragile, as the sustainability of growth and the outlook remain very dependent on the evolution of the coronavirus (COVID-19). More significant overheating signals are unlikely to be apparent until mid-2022, in our opinion.
Is the recovery driven by credit? Here, a simple “no” will do. Despite better than expected momentum in 2020, loan growth remains essentially stuck at a lower number. The traditionally low financial intermediation ratio (24.6% in 2019) improved in 2020 (to 26%) but not entirely for the right reasons. The contraction in GDP also played a role.
The exchange rate effect: the impact of the exchange rate on inflation is noticeably high in Romania (around 0.2 pts for each 1% depreciation of the leu, although this estimate can vary considerably depending on many factors and hypotheses). A rate hike would certainly help ease the downward pressure. However, we believe the NBR is capable and ready to maintain exchange rate stability without reverting to key rate hikes (more on our views on exchange rates here).
As a result, a possible rate hike would likely work primarily through the expectations channel, which again – given the nature of the current inflation peak – is probably suboptimal as a policy choice.
Despite all of the above and although not our base scenario, a 2H21 rate hike scenario is certainly not easily dismissed. This will of course depend on inflation itself, but also on the strength of the economic recovery and – not the least – other regional central banks. However, we believe the NBR has longer to wait than other central banks. Its previous policy choices have also shown that the Bank does not hesitate to also resort to non-transparent tightening, generally as part of its liquidity management strategy. We expect that banking system liquidity will gradually shift to a neutral or even slightly short liquidity position by the start of 3Q21 and that repo transactions (possibly on a bilateral basis again) will be used. The relative stability of the € / RON rate should also be part of the NBR’s strategy in its fight against current inflation.
If the current scenario presented in the last inflation report turns out to be correct – a scenario that we consider realistic – We believe that the NBR will not resort to key rate hikes in 2021. We therefore maintain our vision of a relatively modest 50bp rate hike in mid-2022 and a gradual shift to tighter management of cash by then.
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