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Tuesday, February 12, 2008

Romania Inflation January 2008

Romanian inflation accelerated in January to the fastest pace in 20 months as the weakening leu increased the cost of local services, including rent and phone bills, many of which are priced in euros. The annual rate rose to 7.3 percent, the highest since May 2006, from 6.6 percent in December, according to data released by the Bucharest-based National Statistics Institute earlier today. Consumer prices rose 0.9 percent month on month, compared with a gain of 0.6 percent from November to December.

The National Bank of Romania, raised its main interest rate 1 percentage point to 9 percent only last week, and is becoming increasingly concerned the inflation rate may rise to over 8 percent in the coming months because of the weakening leu, wage increases, a consumer lending boom and increased government spending.

The leu has droped almost 13 percent against the euro since last August, and this has made goods and services indexed in foreign currencies more expensive. In Romania, telephone bills, gas, rent and other items are quoted in euros and paid in lei.

The price of services, the area most sensitive to leu fluctuations, increased an annual 9.7 percent in January, the institute said. Food prices also rose an annual 9.7 percent because of a drought that destroyed a third of Romania's harvest last year. The cost of non-food goods increased 4.2 percent.

In January, rents rose an average of 1 percent from December and phone bills increased 4.4 percent, the INSSE said.

The central bank, which has now raised its main interest rate at three consecutive meetings, is likely to continue raising the rate in the future, and some economists are even forecasting that they may continue until it reaches 10 percent. The central bank's next interest rate meeting is on March 26.

Central bank Governor Mugur Isarescu raised his end-year inflation prediction on Feb. 7 to 5.9 percent from an earlier estimate of 4.3 percent. This forecast is above the 2008 end-year inflation target of 3.8 percent, plus or minus a percentage point. The central bank also missed the end-year 2007 target of 4 percent, plus or minus one point, as inflation rose an annual 6.6 percent in December.

One of the difficulties is that policymakers are treating this problem as if it is merely cyclical, whereas I fear it is structural, and that getting 6 percent inflation-free annual growth rates may be near impossible now in Romania due to the severe problems of lack of labour.

Of course, predictably the leu rose on the news, climbing to 3.6232 against the euro by 3:54 p.m. in Bucharest, from 3.6513 yesterday. If the currency movement was the main inflation issue, then this would provide a kind of automatic stabiliser mechanism raising the leu and damping inflation. Unfortunately, as I keep saying, my own view is that the problem is much deeper, and the real difficulty is that what is happening now is a kind of lock-in risk premium, whereby it may well prove very much more difficult for the central bank to subsequently lower rates than it is now proving to raise them, in which case the Romanian economy could soon find itself set on the course on whicb the Hungarian one has already embarked.

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