Thursday, March 3, 2011

Inflation, weak leu hit Romania rate cut prospects

By Luiza Ilie

BUCHAREST, March 2 (Reuters) - Romania's central bank may confound expectations of a cut in interest rates this year as it struggles with imported inflation and, alone in central Europe, a currency that has not benefited from an emerging market boom.

A Reuters poll last month showed analysts forecasting rate cuts later this year as the impact on prices of a value-added tax hike fades and Romania prepares to sign a new precautionary aid deal with the International Monetary Fund.

The deal is a mark of the progress Romania has made since it was bailed out in the aftermath of the 2008 financial crisis and should ease concerns over the fate of its currency that have weighed on the bank's decision to keep rates high since May.

But with growth still weak, the budget under pressure and the economy facing a surge in oil prices as well as reforms of local energy markets that will prod prices higher, there seems little prospect that the leu will jump or inflation will ease.

January inflation came in higher than expected at 7 percent, the highest in the European Union, and some analysts are already swinging round to forecast interest rates either on hold at the current 6.25 percent this year or even conceivably rising.

"The central bank will not cut rates this year. In fact, there are upside risks for a hike," said ING Bank Romania chief economist Nicolaie Alexandru-Chidesciuc. "I find it hard to believe we will not have imported inflation."



WAITING GAME

While most analysts say they will wait for more signals from policymakers before revising their estimates, they acknowledge inflationary risks have picked up and some say there is a chance the bank may have to raise rates in late 2011 to protect its 2-4 percent inflation goals for this year and next.

Alternatively, the bank could freeze rates and favour a stronger leu, either via indirect intervention or by gradually tightening liquidity, boosting money market rates.

Either, however, would nudge five-year debt yields up from current levels of around 7.2 percent, increasing the government's borrowing costs, while holding back an already slow economic recovery -- 2011 growth is seen at just 1.5 percent.

Forecasts for domestic demand in 2011 are barely more positive and any rise in borrowing costs will be deeply unpopular with a population reeling from two years of draconian budget cuts in the EU's poorest country by per capita income.

"Risks are higher but ... in light of recent developments we are waiting for a message from the central bank," said Ionut Dumitru, chief economist at Raiffeisen Bank in Bucharest.



FOREX RISE

Currency gains have allowed other European central banks to keep rates low even as their economies recovered strongly from the 2008 crisis, but Poland and Hungary have already raised rates and the Czech Republic is expected to follow.

While the leu has held stable against the euro at levels similar to June 2010, the Polish zloty is up 3 percent since then and the Czech crown 5 percent.

As for mitigating higher commodities costs, usually priced in dollars, the Polish zloty has gained 17 percent against the dollar since June and the Czech crown 19 percent -- whereas the leu's rise is around 12 percent and inflation is correspondingly higher in Romania.

Romania's central bank has forecast inflation will fall from end-December's 8 percent to 3.6 percent at the end of this year, within its 2-4 percent band, but price growth has consistently overshot central bank targets since 2005.

While headline inflation fell in January, it was higher than expected due to rising food costs and core inflation was also still elevated at 5.1 percent.

Food, fuel and energy also make up more than 50 percent of the inflation basket, compared with 30-40 percent in Hungary, Poland or the Czech Republic and less in other EU states.

Those prices have jumped significantly. The Goldman Sachs commodities index has risen 46 percent since last June, and crude oil is up some 59 percent.

"In 2012, the central bank will probably be surprised by higher inflation than what they have in their projections," said Miroslav Plojhar, EMEA economist at JP Morgan, the only analyst in the Reuters poll that saw rates higher by the end of 2011.

"So a potential rate hike will be like trying to show that they are managing things, that they have things under control." (Additional reporting by Ioana Patran and Sam Cage; editing by Patrick Graham and Stephen Nisbet)

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