Wednesday, November 3, 2010

Romanian Central Bank Leaves Benchmark Interest Rate at Record-Low 6.25%

Romania’s central bank kept its benchmark rate unchanged as policy makers stick to a “prudent stance” because of concerns about rising prices prompted by a tax increase and the impact of the government’s fiscal policy amid political tensions.

The Banca Nationala a Romaniei in Bucharest today left the monetary policy rate at a record-low 6.25 percent for the fourth meeting in a row, matching the expectations of all seven economists surveyed by Bloomberg. The central bank also said it will set an “ambitious” annual fixed target for inflation of 2.5 percent, plus or minus 1 percent, from 2013 and set a 3 percent target for 2012.

“The central bank is setting a quite ambitious inflation target,” said Miroslav Plojhar, an economist at JP Morgan Chase & Co. in London, after the interest-rate announcement. “The bank would like to push the target toward the ECB’s one to keep the current target of euro adoption alive.”

The government, which secured 20 billion euros ($27.8 billion) of loans from the International Monetary Fund, the European Union and other lenders to stay afloat, raised the VAT by 5 points to 24 percent in July, boosting inflation to the fastest pace in more than two years.

The central bank sees the higher VAT having a “gradual pass-through of its first round effect.” Policy makers stopped cutting borrowing costs in June after lowering rates four times. The Balkan nation’s economy is mired in the worst recession on record.

New Target

Policy makers will discuss the new inflation target with the government, the central bank said today after approving an report that will be made public at a press conference later this week.

The bank forecast on Aug. 4 that inflation will end the year at 7.8 percent and slow to 3.1 percent at the end of 2011 after the effects of the VAT increase disperse.

“Concerns remain over the possible second-round effects of the VAT rate hike, a potential higher-than-anticipated adjustment in administered prices compared with the envisaged when the forecast was prepared and uncertainties related to the impact of fiscal consolidation measures given the tense political and social climate, thus requiring a continued prudent monetary policy stance,” the central bank said in a statement after the decision.

No Confidence

The government, which survived two no-confidence votes in parliament this year over unpopular wage cuts and VAT increase, is struggling to get next year’s budget and pension laws approved to meet the terms of its international bailout, as the opposition and unions try to persuade the ruling coalition lawmakers to bring down Prime Minister Emil Boc’s cabinet.

Boc will probably face a third no-confidence vote over a proposed education law as early as this week because of opposition Liberal and Social Democrat challenges.

The bank left its minimum reserve requirements at 25 percent on foreign-exchange deposits and at 15 percent on lei savings. The leu weakened 0.3 percent to 4.291 as of 4:25 p.m. in Bucharest trading after the decision.

‘True Tightening’

“Inflation is likely to drop toward 4 percent in the second half of next year,” Plojhar said. The key interest rate “will be higher at the end of 2011, given an expected recovery in domestic demand and therefore in inflation, up about 50 basis points, so rather a signal than true tightening.”

Romania’s economy will probably contract as much as 2 percent in 2010 as austerity measures damp consumer demand, IMF Mission Chief to Romania Jeffrey Franks said yesterday. The economy will likely return to growth in the fourth quarter of this year, Franks said.

Romania’s economy contracted in the third quarter because of the wage cuts and higher VAT, Franks said. GDP growth may be “perhaps slightly positive” in the fourth quarter and “certainly” expand in the first and second three-month periods in 2011, he said.

Romanian monetary policy is “broadly appropriate,” Franks said in an interview in Bucharest yesterday. The central bank has room to lower its benchmark interest rate if inflation slows as the effects of the VAT increase dissipate next year, he said.

“The central bank has made a decision to pause,” he said. “If inflation begins to come down, then there may be room in the future for additional interest-rate easing.”

The central bank’s main interest rate accommodates a “temporary” surge in inflation, which is expected to end the year at 7.8 percent, Deputy Governor Cristian Popa said on Oct. 20. Such a result would be above the bank’s target of 2.5 percent to 4.5 percent. Popa said he expects the effect of the VAT change on inflation to start slowing after July 2011.

To contact the reporter on this story: Irina Savu in Bucharest at isavu@bloomberg.net.

To contact the editor responsible for this story: James M. Gomez in Prague atjagomez@bloomberg.net

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