Bancherul - BANCI / ENGLISH / BCR economists forecast for 2013 an inflation much higher than the National Bank of Romania (NBR) estimates

BCR economists forecast for 2013 an inflation much higher than the National Bank of Romania (NBR) forecat of 3.5%, the upper limit of the target range, considered "far too optimistic" and which could confirm only if there will be an agricultural year extremely good, similar to that of 2011.

BCR expects inflation to surge to 5.5% in December 2012 and 4.7% in December 2013, more than 1% above the central bank forecast.

Regarding monetary policy, BCR thinks it will remain at 5.25% next year, although governor Isarescu hinted at last press conference that it is possible even a decrease, to help the economy.

BCR:

"In the latest Inflation report issued on Wednesday, the central bank admitted that it has come up against a pretty tough choice (monetary policywise): helping a weak economy – pointing to the sizable deficit of the aggregate demand – and increasing the key rate in the face of resurging
inflation.

The dilemma gets even trickier as higher interest rates may push to the back burner, at least for a while, ongoing plans to shift lending to RON from FX. Although the central bank sees the recent spike in inflation as a temporary hiccup, it has raised the inflation forecast for both end-2012 and 2013 to 5.1% (from a previous 3.2%) and 3.5% (from 3%), respectively.

Last week, in the detailed press release issued shortly after the key rate was left unchanged at 5.25%, the National Bank changed the wording to ‘firm’ from ‘adequate’ when referring to liquidity management.

This hints at further capping the liquidity injections through a 1-week repo in the period going forward. Keeping liquidity in check twinned with interventions stemmed the leu depreciation in recent weeks. The leu currently trades at 4.51 against the European single currency.

We stick to our view on inflation and see it gliding over the central bank’s target range both in the remainder of this year and in 2013, while we postpone the chances of seeing it back within target until after 2013.

The announced price liberalization of energy prices next year (natural gas and electricity), not to mention the rise in excise duties pegged at a much weaker EUR/RON (4.52) is likely to drive inflation up by at least 1-1.5% in 2013.

Unquestionably, the negative output gap will still be there next year, suggesting muted pressure from demand-pull inflation. But no less true is – and this part is usually left out of the story – that GDP deviation from its potential, whether negative or positive, explains only 5% of the overall inflation change in the short term.

According to our baseline scenario, we expect inflation to peak at 6.8% in 2Q12 and any prospective hike in the base rate should mainly be seen in the wider context of sending out reassuring signals – especially to foreign investors – that everything is under control.

Investor expectations for a key rate change usually run high when inflation numbers are far off the target and signs of improvement are not very clear. Moreover, the European landscape remains riven with uncertainties and no one knows for sure what will come next. Meanwhile, the European Commission has pared down the Eurozone’s economic growth forecast for 2013 to 0.1% from 1%, presaging lean times ahead.

The central bank’s new inflation scenario is more dovish than ours and bets on inflation landing dead on the upper bound of the target range (3.5%) in December 2013.

Even though the central bank will never come up with an inflation forecast y+1 outside the target, we cannot help seeing it as overly optimistic, unless of course God blesses Romania with a bonanza agricultural year like in 2011.

We stick to our inflation forecast of 5.5% for end-2012 and 4.7% and for the time being see the key rate flat at 5.25% for the entire horizon.

After all, tighter liquidity management can roughly be a substitute for an increase in the base rate. But for how long?"