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“They say what popular vote wants, we say what economy can do”: BNR increases key interest rate

de Adrian N Ionescu , 14.5.2018

The National Bank of Romania (BNR) surprised a part of the market on Monday with the decision to raise its monetary policy rate to 2.5% (from 2.25%).

The increase in the key rate occurred despite the auspices that appeared to be against this event, following last week’s meeting between BNR Governor Mugur Isarescu and the President of the Chamber of Deputies, Liviu Dragnea.

This is the third increase this year, with the other two applied in January, by 25 basis points each, from the level of 1.75% where 2018 started.

The BNR Board of Directors unanimously decided to increase the key interest rate, according to BNR Governor Mugur Isarescu.

“Harmonizing” Government and BNR

At the same time, the BNR continues to support the “harmonization” of the government and monetary policies, according to BNR Governor’s statements made on Monday.

The Government and the Parliament come with the popular vote and say: this is what the Romanian society wants. Can we say the society does not want that? This is a necessity – because of the labour migration, salaries are rising. They say what the popular vote wants, we say how much economy can do. It would good for us to meet somewhere in this discussion!,” said Mugur Isarescu

I am not saying that harmonization is now complete, but we are doing better,” said the BNR Governor, asked about the discussions with the President of the Chamber of Deputies.

“Popular vote” and economy

On the other hand, between the “popular vote” and what the “economy wants”, the natural prudence of BNR intervenes, which, “as any central bank”, seeks to avoid potential, painful adjustments of imbalances, according to Mugur Isarescu’s statements.

“We are more cautious because the demand surplus is not commensurate. You can only say exactly how big it is when it appears, like the litmus test, in the current account balance. At that point, you cannot lie anymore, and then it is a little too late, as there are already a lot of pressures on the exchange rate, the interest rate, and the correction can be painful.”

This is “BNR’s judgment, as well as the judgement of central banks: it is more difficult to correct the demand by cutting it, by raising the interest rates and taxes. That is why we are more cautious so that the society to not make these painful corrections,” explained the BNR Governor.

Where is interest rate heading?

The BNR Governor reminded that “the age – because it was an age, of almost 10 years – of very low and real negative interest rates is gone”.

Normalizing the interest rate, in the “classical sense, that we shall reach positive interest rates, is a process that we cannot shape in the future, but because there are still real negative interest rates in Europe, our interest rate is also below inflation,” added Mugur Isarescu.

Consequently, “those who make judgments like <<we shall raise interest rates in Romania because they must reach the inflation rate>> are wrong, because we shall also maintain a gap, I do not know whether it will be like in Europe, the markets will tell us. There is about two percent gap between the inflation rate and the interest rate there. I do not know if it will be of two percent in Romania as well. For now, it is still of two percent if you look at figures, but this gap will maintain,” the BNR Governor also said.

“That does not mean it will happen what I want to happen, I am not empowered by the Board, but I am the Governor of the National Bank. I would like for this inflation curve, which you will see on Wednesday (in the BNR report on this topic, editor’s note), to go down and the interest rate curve to not be very upward and one day, they will meet at a level very close to what it will be in Europe,” Mugur Isarescu explained.

BNR’s arguments

“The new forecast scenario (on inflation) reconfirms the prospect of a slight increase and capping of the annual inflation rate during the course of some months, above the target range, followed by its return by the end of this year close to the upper limit of the range,” according to BNR.

At the same time, “uncertainties and risks associated with the inflation outlook come mainly from:

  • administered prices,
  • labour market conditions and
  • future evolution of the international oil price.

The economic growth rhythm and inflation in the Eurozone and, implicitly, the conduct of the ECB’s monetary policy and the policies of the central banks in the region are also relevant.

Other milestones:

  • The annual inflation rate continued to rise to 4.95% in March 2018 from 4.72% in the previous month.
  • The advance of the (inflationary) rhythm has mainly been driven by the factors from the supply side, especially the fuel price increase, as well as the core component of the adjusted CORE 2 inflation, whose annual rate continued to rise to 3.0% in March, from 2.9% in February.
  • The advance of the adjusted CORE2 inflation index reflects:
  • pressures from the surplus of the aggregate demand in the economy,
  • increase in production costs (labour, utilities),
  • some influences of Romanian leu exchange rate dynamics, but also
  • the continuation of the upward adjustment of short-term inflation expectations.
  • The negative contribution of net exports to real GDP growth remained unchanged.
  • The deterioration of the balance of goods and services and, consequently, the widening of the current account deficit in the first two months of 2018 compared to the same period of the previous year.
  • Monetary conditions continued to moderate their accommodating nature in April, in the context of the increase in the relevant quotations of the money market and the relative stability of the Romanian leu exchange rate.
  • The annual dynamic of credit to the private sector remained at 6.1% in March. The RON component continued to increase its share in the total credit to 63.6% (from a minimum level of 35.6% in May 2012).
  • The credit provided to the population increased its annual growth (9.4%) with the dominant contribution of consumer credit.

BNR also took the decisions:

  • The increase in the interest rate for the deposit facility to 1.50% per year from 1.25% per year and the interest rate in the lending facility to 3.50% per year from 3.25% per year as of 8 May 2018;
  • Maintaining the current levels of the reserve ratios applicable to RON and foreign currency liabilities of credit institutions.

Banks explain

The BNR decision seems to be far from a concession that casts a shade on the independence of the central bank, especially that tightening the monetary policy is illustrated not only by the increase in the key interest rate but also the increase in the interest rates on deposit and credit (as a last resort) facilities to banks.


“Today’s decision is not a surprise, it seems to me perfectly consistent with the macroeconomic and market context, both local and global.

This decision proves to me that the independence of the National Bank in pursuing its mandate (to maintain price stability in mid-term) is in full use, as it should be normal,” said Horia Braun Erdei (PHOTO), BCR Chief economist for

The decision took on Monday to raise the policy interest was expected even since the last month because of the continued inflationary shocks.

However, BNR preferred to keep the level unchanged and continue to attract liquidity from the market, to stimulate the growth of interest rates on the market.

“We believe that increase in inflation in the first quarter, as well as the oil price evolution higher than expectations, may imply the revision of the inflation target. Even if it will not be reviewed, the current 3.5% target, as well as the upward trend in the CORE inflation (without the administered prices, editor’s note), provides a sufficient basis (for raising the interest rates), according to a note from BCR Research issued last week.

According to Banca Transilvania, the decision to increase the policy interest rate was determined not only by:

  • the high level of inflation (and the importance of anchoring the short – term inflation expectations) and
  • the deterioration of macroeconomic balance, but also by
  • the need to make room for manoeuvre to intervene at the moment of occurring some adverse economic shocks in the economy.
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