Monetary Easing Back On Following Surprise Cut

Following a fresh 50bps cut to the National Bank of Romania's policy rate, we believe that a return to monetary easing is now on the cards following several months of static rates amid the ongoing political crisis. Given the early cut this year and scope for further easing (Romanian rates are the highest in the EU), we now target an end-2010 policy rate of 6.50%.

In a sign that monetary easing is now back on the agenda, the National Bank of Romania surprised the market with a 50bps cut to its main policy rate (to 7.50%) on December 5. This affirms our previous view that the NBR would wait until a new government was installed and political stability improved, before cutting rates further in order to avoid a run on the leu. To this end, parliament's approval of Prime Minister Emil Boc's centrist government on December 24 has defused the political crisis in play since October, paving the way for a return to monetary easing.

With the NBR's policy rate being the highest in the EU, and with the economy still in the throes of deep recession, we see scope for significant rate cuts going forward. Indeed, the need to revive the domestic lending channel and provide further liquidity to households and firms, in a bid to accelerate the broader economic recovery (which currently lags the eurozone by several quarters), underscores our projection for a further 100bps in cumulative rate cuts by end year. Indeed, having previously targeted an end-2010 policy rate of 7.00%, we have now revised down our forecast to 6.50% on the back of the early rate cut this year and further scope for additional cuts.

Concerns Remain Over Financial Market Stability And Inflation

While we expect the NBR to deliver 100bps in monetary easing this year, we expect rate cuts to be both piecemeal and measured. In the immediate term, the central bank will likely wait for the 2010 budget to be finalised and written into law before adjusting the policy rate again. To be sure, though the government has indicated that it wants the budget passed by mid-January in order to swiftly free up the next two tranches from the IMF's loan package, there remain risks that the bill could be delayed. A failure to secure parliamentary backing in January, followed by revisions to the proposed budget, would keep the IMF from releasing additional funds for the time being.

Under this scenario, the NBR would be cautious of cutting rates further for fear of upsetting financial market stability in light of the still uncertain political and economic outlook. To be sure, though the leu has responded positively to the NBR's 50bps cut yesterday, surging to its strongest level since May 2009, we caution that cutting rates too far and too fast could see a spike in risk aversion and fuel depreciatory pressures, particularly at a time of elevated political uncertainty.

We also stress that inflation remains stubbornly above the central bank's target, with further monetary easing potentially impeding the NBR's inflation targeting agenda. To be sure, though inflation has edged lower since the mid-2008 peak, the headline reading (4.7% y-o-y in November) remains outside the NBR's 3.5% target for 2010. As such, while further rate cuts would bolster domestic credit conditions, it could do so at the risk of fuelling inflationary pressures, as well as spurring leu depreciation, in turn hitting consumers paying utility bills which are priced in euros and paid in leu. As a result of these aforementioned factors, we expect the central bank to adopt for a more cautious 'wait and see' approach to monetary policy, opting for measured cuts of 25-50bps through the year."

 

Source: Emerging Europe Monitor

 

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