Romanian rates policy

BASEL – Global monetary tightening and a falling leu currency provide room for Romania to raise its interest rates to combat inflation, the central bank governor, Mugur Isarescu, said on Sunday. In an interview with Reuters ahead of the bank’s policy meeting yesterday, Isarescu said he sees no sign that domestic inflationary trends are worsening, but price gains are likely to be just above the central bank’s target this year. This inflationary outcome would increase the probability that rates would be raised, he said. «I cannot say there will not be additional monetary tightening,» Isarescu told Reuters when asked if a rate hike would be needed to bring inflation back into the central bank’s target range of 4-6 percent this year and 3-5 percent next year. Moreover, Isarescu said the conditions are in place that make it easier for the central bank to raise rates than those that have prevailed for Romania in recent months. «With the clear trend toward increases in interest rates both in the United States and in the eurozone, the interest rate differential is narrowing and our room for maneuver becomes larger,» he said. Romania had faced constraints over how much it could raise domestic interest rates because a central bank rate of 8.5 percent was attracting large amounts of capital into the country, putting upward pressure on the leu. But the leu currency, in line with other emerging markets, has retreated recently falling to a five-month low against the euro on Friday after having rallied some 7 percent in 2005 despite central bank intervention. Isarescu welcomed its retreat. «This is adding to our room for maneuver and allowing us to breathe,» he said. «Now increasing interest rates is more rational than it was with the irrational appreciation of the currency,» he said, speaking to Reuters on the sidelines of central bank meetings at the Bank for International Settlements, which was holding its annual meeting here yesterday. Inflation outlook Inflation stood at 6.9 percent in April, the lowest level since the fall of communism in 1989 but still outside the National Bank of Romania’s range for the year. Recently, it raised the year-end forecast to 6.8 percent. Isarescu did not express great concern that the government’s announcement to double the budget deficit to 2 percent of GDP would prove inflationary if the plan to spend 80 percent of the new financing on infrastructure and investments was adhered to. «According to our preliminary estimates, (the impact) will be largely on the balance of payments, and not much into inflation,» he said without estimating the precise amount. In May, June and July of this year, indirect taxes were expected to place pressure on the inflation numbers, but Isarescu said that price gains overall and particularly core inflation are moving in line with expectations laid out in the central bank’s report. «Personally, I have the feeling inflation is not worsening. It will be marginally above 6 percent. Next year it will be below 4 percent,» he said. While disinflationary trends are in place, Isarescu said the important factor is to ensure improvements are sustainable. This was the primary message the Romanian central bank took from the European Union’s decision not to admit Lithuania into the eurozone for narrowly missing the price target. Accordingly, the central bank considers 2114 as a reasonable target date for euro adoption after it has become an EU member, with a two-year period in the ERM-2 currency band testing its readiness, he said. Romania is seeking EU entry by 2007 or 2008. As for growth this year, Isarescu said Romania could exceed the 5.5 percent GDP forecast. «It could be higher and then we have to look carefully if a higher growth rate does not conflict with inflation.» Growth probably will continue at the current rate for several more years, even though by year-end 2006 excess aggregate demand from pent-up consumer spending after the lean years of communism should have reached zero, Isarescu said.

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