National Bank of Romania could leave unchanged the monetary policy rate in 2017, according to BCR economists. The reason is the perspective of a low inflation just above the lower end of the target band (1.5-3.5%) at the end of 2017 (+1.7%).

The central bank left the monetary policy rate unchanged at 1.75% (note of BCR analyst Dumitru Dulgheru):

In his speech held soon after the decision, Governor Mugur Isarescu said that inflation will spring back into positive territory in the first quarter of this year, but the magnitude of the rebound will be softer than in the central bank’s forecast which currently stands at +0.8%.

The press release detailed that the inflation bounce-back will be supported by a base effect once the VAT cut to 20% washes out, a positive output gap and higher unit labor costs.

As usual, the governor noted that main risks to the inflation forecast come from Eurozone growth concerns, the problems facing the European banking sector, Brexit negotiations and the international price of oil.

As for the locally originating risks, the central bank chief mentioned that the 2017 country budget is needed to calibrate the monetary policy ahead.

He explained that the budget construction depends on the 5.5% economic growth forecast (included in the Social-Democrats' Governing Program).

The governor specified that the central bank sees the Ministry of Finance goal to keep the budget deficit below 3% of GDP as a commitment.

Answering a question from the audience, the governor said there are risks arising from post-election developments.

Our view:

We continue to project a rebound in inflation this year. In view of the elimination of the extra excise duty for fuels and further VAT cut to 19% and a cheaper electricity bill, the upward path of inflation in the first half of the year could be somewhat milder than we had previously expected.

However, a further loose public wage policy coupled with tax cuts/reduction by income brackets in the case of state pensions heralded by the new Social-Democrat administration could turn the heat up on inflation.

We are looking for the central bank to leave the key rate unchanged this year, as we continue to see annual inflation hovering just above the lower end of the target band (1.5-3.5%) at the end of 2017 (+1.7%).

However, growing prospects for higher interest rates in the US, against a backdrop of skittish investor sentiment associated with Brexit and a sense of unease from a string of elections in the Netherlands, France and Germany, could increase the risk of capital outflows for CEE markets.

Moreover, further widening of the budget deficit in Romania – following the government’s strong bias towards wages and welfare spending – adds to the uncertainty, putting upside pressure on government funding costs this year. Next monetary policy meeting is scheduled for February 7.