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Monday, February 4, 2008

Romania Central Bank Raises Policy Rate To 9%

Romania's central bank unexpectedly raised its benchmark interest rate a full point, the third consecutive increase, as inflation threatens to accelerate and the local currency weakens. The central bank increased its Monetary Policy Rate to 9 percent, the highest since 2005, from the 8 percent level set on 7 January 2008. This is now a very strong monetary tightening process.

The bank will ``continue to pursue a form of management of money-market liquidity'' and adopt ``higher provisioning for foreign exchange-denominated credits extended to unhedged borrowers,'' it said in a note about the decision.

Net monthly wages rose an annual 23.5 percent in November and private debt increased an annual 60 percent in December, most of it in euros.

More to the point on the debt front, household borrowing in foreign exchange denominated debt (largely euros) rose at an annual rate of 134.4% in December.

Central Bank governor Mugur Isarescu has repeatedly warned that rapid increases in euro-denominated loans pose risks to borrowers as a weaker local currency could increase their borrowing costs. Basically this situation places a limit on the central banks own monetary policy to put a break on credit expansion, especially if at some point the ECB starts to reduce rates.

Surprisingly this news of central bank rate increases due to strong inflation is pushing the leu upwards, and the currency advanced to a more than three-week high against the euro this morning on speculation the central bank will increase interest rates by half a percentage point to 8.5 percent later today.

The leu rose to 3.6429, the strongest level since Jan. 10, and traded at 3.6449 at 9:02 a.m. in Bucharest, from 3.6703 on Feb. 1.

This effect is very counter productive, since it raises a real excahnge rate which is already being pushed up by the inflation itself, only serving to deteriorate further and already battered trade deficit as exports become more expensive and imports cheaper. We could call all of this the perverse consequence of traditional monetary policy in the current environment.

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