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Monday, February 4, 2008

Inflation and the Leu

The Romanian government authorised an increase in the price of natural gas by 8.5 percent as of 1 February 2008. According to an article today in the Romanian newspaper Ziarul Financiar this could push up food prices significantly, starting from as early as this month. Food prices, which have been one of the drivers of Romanian inflation since a drought destroyed crops last year, may rise by as much as 0.7 percent simply as a result of the gas price rise the newspaper said, citing unidentified Finance Ministry officials.

Surprisingly this news of possible increases in 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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