Inflation Snapback Means Tighter Policy Sooner for Romania

  • Central bank governor says interest-rate corridor to narrow
  • Surging consumer demand set to end bout of deflation

Romania’s central bank governor sees monetary policy being tightened sooner than previously envisaged with inflation set to return after the first bout of consumer-price declines since communism.

Surging consumer demand has propelled economic growth to among the European Union’s fastest and may completely offset the deflationary effect of the government’s latest round of tax cuts, Mugur Isarescu said in Bucharest. The bank’s first response to resurgent consumer prices will be to narrow the interest-rate corridor, used for liquidity management, and may come this year, he said.

“We are going to react more rapidly, but not with the policy rate,” Isarescu said Tuesday in an interview in the central bank’s board room. “After moving the corridor, perhaps the policy rate will follow.”

Isarescu, the EU’s longest-serving central bank governor, is facing a swing from what he calls temporary price declines triggered by reductions in the sales tax to inflation that could challenge policy makers’ goal next year. The Banca Nationala a Romaniei also faces challenges from a general election later this year, with the government’s fiscal policy contributing to threats the economy will overheat.

The leu has outperformed currencies in other developing nations, where the slowdown in China’s economy as well as recessions in Russia and Brazil have wreaked havoc. The leu has gained 1.1 percent against the euro in 2016, the third-best performance among 24 emerging-market currencies tracked by Bloomberg behind Hungary’s forint.

Romania’s currency is trading “more or less” at fair value, according to Isarescu. As part efforts to seek euro-region membership by 2019, the central bank pledged to relax banks’ reserve requirements to EU levels. The next stage of reductions may be postponed to 2017 because of looser fiscal policy in the run-up to parliamentary elections toward year-end.

“I couldn’t say for example that it’s compulsory to have another window of opportunity this year” to trim reserve requirements, he said.

Economic growth accelerated to 3.7 percent from a year earlier in the fourth quarter from 3.6 percent in the previous three months. Inflation will quicken to 3.4 percent by the end of 2017, according to the central bank, which targets a range from 1.5 percent to 3.5 percent. Prices declined an annual 2.1 percent in January and will start rising by the middle of this year, the bank predicts.

‘Real Challenge’

The turnaround in inflation and booming consumption has prompted concern that the economy could overheat. While that scenario probably won’t materialize this year, it’s a possibility in 2017, Isarescu said. Gross domestic product may increase by more than 4 percent in 2016, according to the governor, who declined to give forecasts beyond that.

Government spending that exceeded 2 percent of economic output in December created a “real challenge” for policy makers, Isarescu said. The central bank currently favors tools other than reverse-repurchase operations to absorb large amounts of excess liquidity that’s appeared during the past two months, he said.

Another issue that could jeopardize banking stability is a draft legislation allowing Romanians who can no longer repay their mortgages to hand back properties to lenders and become debt-free. Isarescu said he hopes the so-called walk-away law will be amended to only serve troubled borrowers and have a limited impact on lending.

The central bank kept the key rate at a record-low 1.75 percent for a sixth meeting Feb. 5, while raising inflation forecast for this year to 1.4 percent.

“We consider that where we are now with the policy rate, we are well situated for any kind of development into the future,” said Isarescu, who’s headed the bank for 25 years and whose final term ends in 2019. “Not too high, not too low.”

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