After the American Civil War, a Confederate soldier wrote to his parents: “Before the war, I went to market with money in my pocket and carried my purchases in a net. Now I go to the bazaar with a money bag and carry my purchases in my pocket. (source). This was long before the creation of the Federal Reserve. Today, central banks, including the Romanian one, have made inflation their number one enemy.

In Romania, the price increase has passed its most intense phase, but it has had a strong impact on purchasing power, especially among those with low incomes. Inflation is falling here, which means that prices will continue to rise, but at a slower pace. On Wednesday, 9 members of the Board of Directors of the National Bank will announce a decision on monetary policy, most likely to maintain the current level of 7%.

Before making a statement, 9 luminaries of the BNR discuss with members of the Monetary Policy Committee (CPM) and several other directors the economic analyzes prepared internally.

In order to be as well informed as possible, Dorina Antokhi, who heads the Office of Monetary Policy, presented 9 members of the BNR Board with several documents, documents in which the progress of the economy was described with numbers from a macro and microeconomic point of view. However, the most important document is the one in which two or three scenarios of possible solutions are presented to the members of the Board of Directors, each of which is accompanied by a presentation of advantages and disadvantages. So that on Wednesday afternoon, when the decision on monetary policy will be announced, each of the 9 members of the Executive Committee of the BNR will analyze all the data as carefully as possible.

Economists bet on maintaining the current level

BCR: We see the key rate at 7.00% until mid-2024

We expect the BNR to keep the monetary policy rate unchanged at 7.00% at the July 5 Board meeting, BCR officials say. The latest inflation forecast is likely to be confirmed. Thus, the monetary meeting will be without big surprises.

Ionuc Dumitru: Our economy developed relatively well

Looking at the numbers, we had a sharp contraction in 2020 where the economy was at least partially halted, after which economic activity recovered quite quickly. In relative terms, economic growth at the local level has been ahead of the region in recent quarters, with an upward trend. Romania’s GDP per capita at purchasing power parity is no longer the lowest or second lowest in Europe, it is even higher than some Eurozone countries such as Greece or Slovakia, and at the same level as Hungary. According to the estimates of the European Commission, if the current trend continues, Romania will probably overtake Poland in two years.

The annual inflation rate this year has a downward trend, reaching 11.2% in April. The slowdown in inflation rates was largely contributed to by the authorities’ decision to freeze energy prices until March 2025 at the level of December 2022. Core inflationary pressure has currently only gradually decreased, remaining at high levels (CORE 3 was 14% per year in April). Annual inflation is expected to moderate this year, possibly reaching 7% in December. In our scenario, annual CORE 3 inflation has a rapid downward trend this year to 8% at the end of the year.

However, both annualized inflation and CORE 3 annualized inflation will remain well above the NDB’s inflation target range until mid-2024. Central banks in CEE countries have aggressively raised monetary policy rates to deal with rising inflation rates. Officially, the key rate hike cycle has ended in Hungary, which may also be relevant for Poland, the Czech Republic, and Romania. Therefore, the NBR is expected to keep the monetary policy rate unchanged at 7% until the 2nd quarter of 2024, when it may begin to lower it. Improved investor sentiment toward lei-denominated government bonds and high government spending have led to excess liquidity in the money market, allowing money market interest rates to decline since last October.

Florian Libocor, BRD: All countries, including Romania, have recovered from the COVID-19 pandemic in a fairly robust manner, but not all sectors have developed at the same pace.

Industry was lower compared to services or construction. Asia and sub-Saharan Africa look set to drive global growth over the next two years, according to data released by the IMF.

In the case of Romania, we are less optimistic, but expectations are still positive. Thus, we estimate a change in GDP in real terms of 2.6% this year and 3.4% next year, which are risks in the political and economic spheres. Inflation is showing visible signs of easing globally, in Romania it has eased to 11.2% y/y in April 2023, but we note that core inflation is still high at around 14% y/y, which should give us fuel for reflections on the acceleration of the deflationary process at the global level.

Monetary policy is responsible for price control or stability, but we begin to discuss different aspects of this process. Inflation has many aspects. One of them is climate inflation caused by natural disasters.

Others are fossil fuel inflation, linked to oil and conventional sources, or green inflation, driven by the costs of switching to green energy. It is also shrinkflation, which is the result of fewer products being available at the same or higher price, or greedflation, which refers to price increases without first increasing production costs.

And then, how can a central bank fight all these types of inflation with traditional instruments? It looks like we will see single digit inflation in Romania in the second quarter of the second half of the year and that could lead to lower interest rate expectations, but not this year while we are dealing with various issues in the economy and still have a fairly high level of CORE.

(Clarification: The opinions of Ionuts Dumitru and Florian Libokor were expressed on the occasion of the annual AAFBR conference held at the headquarters of the BNR)

What about key interests? How does it work for the economy?

Indicative interest rates, also known as “reference interest rates”, “benchmark rates” or “base rates”, are interest rates that are updated regularly and are publicly available. They are a useful basis for all types of financial contracts, such as mortgages, overdrafts and other more complex financial transactions, the ECB says

Estimated rates reflect the cost of borrowing in various markets. For example, they may reflect the costs that banks incur to borrow from each other or to obtain funds from other sources, such as pension funds, insurance companies and money market funds.

Therefore, rates play an important role in the financial and banking system, as well as the economy as a whole. But what exactly makes them so important?

Why are reference interest rates important?

Reference interest rates are widely used by individuals and organizations throughout the economic system.

For example, banks use them when issuing loans to private or corporate clients.

A bank may agree to lend money to a company at an agreed interest rate set at a certain base interest rate plus 2%, meaning that the company will pay 2% interest on top of the current base rate.

Therefore, the cost of borrowing increases if the base interest rate rises and decreases if the base interest rate falls. In this case, the reference interest rate can be a reliable, independent and relatively simple guide for all parties involved.

Companies, banks and other organizations may also use reference interest rates to evaluate balance sheet positions; in other words, these ratios allow the accountant to more easily calculate what the companies (or rather, the financial assets they hold) are ultimately worth.

Other uses of base interest rates include calculating overdraft penalties on cash accounts, calculating interest on some retail deposits, and matching interest rates on mortgages and retail loans.

Reference interest rates help central banks to perform their functions

Base interest rates can also support the activities of central banks. The NBR, for example, helps them in their activities to maintain price stability.

If the base interest rate accurately reflects the rates at which banks make and lend, it can help us better understand the functioning of financial markets and the availability of money.

If you know how easily banks get access to funds, you can estimate how quickly these banks will be able to transfer funds in the form of loans to companies and the population. And all this is ultimately reflected in the price level.