Romania Holds Key Rate With Tax Cuts Set to Deepen Deflation

Updated on
  • Decision matches estimates of all 18 economists in survey
  • CPI falling for first time since communism as GDP surges

Romania’s central bank kept borrowing costs unchanged for a sixth meeting as tax cuts at the start of the year added downward pressure on prices in the eastern European nation’s first bout of deflation since the fall of communism.

The benchmark interest rate was left at a record-low 1.75 percent, the National Bank of Romania said in an e-mailed statement Friday, matching the predictions of all 18 economists in a Bloomberg survey. The bank maintained reserve requirements for foreign-currency liabilities at 12 percent and kept those for leu deposits at 8 percent. It also approved an updated inflation forecast, which points to price growth returning to within target “at the beginning of 2017 and remaining there afterwards,” Governor Mugur Isarescu said.

Rate setters in the European Union’s second-poorest country are facing opposing signals as consumer prices decline for the first time in more than 25 years and cuts in the sales tax help drive economic growth to one of the fastest paces in the bloc. Policy makers are also preparing for potential further easing by the European Central Bank. At the same time, a general election due toward the end of 2016 may trigger more budget spending by authorities, whose tax cuts are already creating uncertainty, Isarescu said.

“The risks to the current projection stem primarily from the domestic environment,” he said. “They are triggered by the uncertainty about the fiscal and income policies, as well as about the implementation of structural reforms, in the context of the elections scheduled to take place this year and in the absence of agreements with international financial institutions.”

Reserve Requirements

Romania’s leu has so far weathered the swings endured by other developing nations. It’s gained 0.5 percent against the euro this year, the second-best performance among 24 emerging-market currencies tracked by Bloomberg, and was 0.3 percent stronger at 4.4961 after the decision, the highest since Dec. 16.

We see “no immediate need for further easing and preventing the economy from overheating, given the extensive fiscal package,” Royal Bank of Scotland Group Plc’s economists Gabor Ambrus and Anna Tokar said in a note. “We continue to expect the bank to gradually reduce minimum reserve requirements.”

Isarescu said the central bank, which has a managed floating policy for the leu, has allowed larger swings in the currency and in money-market interest rates in the past three months as “a monetary-policy option.” 

He also pledged to continue a trend of gradually narrowing the spread between the key rate and money market rates “at the right time and at the right pace,” Isarescu said.

Romanian consumer prices fell 0.9 percent from a year earlier in December, dropping for the seventh month. Isarescu has said deflation, which he deems a temporary result of cuts in the value-added tax, will turn positive in mid-2016.

Gross domestic product jumped 3.6 percent from a year earlier in the third quarter, accelerating from 3.4 percent in the the previous three months as the tax cuts bolstered consumer spending. Economic growth will reach 4.2 percent this year, the second-quickest in the EU, according European Commission winter forecasts released Thursday.

Some nearby nations are demonstrating similar trends: Poland left its benchmark interest rate at a record low Wednesday after economic growth hit a four-year high and deflation extended into an 18th month.