Moldova’s central bank cut the monetary policy interest rate by a massive 3pp to 10% at its July 4 monetary board meeting.

This was the deepest of the five rate cuts made since February 25, that brought the monetary policy interest rate down by a total of 9.5pp from 19.5% - the past decade’s record high reached last August. Disinflation has continued in line with expectations, but lending activity has lost ground amid high interest rates, the monetary authority said, explaining its move.

The monetary policy pass-through to loan interest rates was visible as of May (latest data available), when the monetary policy rate was still 15% and the interest rate on corporate loans with maturities of over one year already decreased below 15% from the peak level of 15.8% hit in December.

Amid the turmoil in the banking system caused by the massive frauds at the three failed banks, followed by a currency crisis in February 2015, Moldova’s central bank increased the monetary policy rate by 16.5pp in less than one year from just 3.5% in November 2014 to 19.5% in August 2015. The move was broadly seen as excessive and too restrictive with respect to financial intermediation.

Disinflation continued for the fifth month in a row in May, when annual consumer price inflation hit 7.9% y/y, in line with the latest forecast, the central bank commented. Headline inflation remains above the 5% +/-1.5pp inflation targeting band, the monetary authority admitted.

The central bank mentioned the economic recovery in Q1, when GDP increased by 0.8% y/y, adding that the short-term indicators for April indicate the continuation of a positive pattern. This included a 10% y/y increase in industrial output, while exports were up by 20% y/y in April.

Moldova’s central bank reduced sharply its forecast for this year’s inflation from 10.1% y/y in its February Inflation Report to 7% y/y in the updated Inflation Report on May 5. Inflation will return within the target range in the third quarter of 2016. The maximum level of 8.1% will be recorded in the second quarter of 2016 and the minimum level of 3.6% in the fourth quarter of 2016.

This was the first inflation projection issued by the central bank since the new governor, Sergiu Cioclea, took office. The central bank also revised the annual inflation forecast for next year from 6.6% y/y to 4.8%.

While the necessity of the record-high monetary policy interest rate enforced by the central bank when faced with local currency depreciation in February 2015 is highly debatable, the negative impact on lending activity is visible. The stock of bank loans contracted by 34% y/y to MDL35.43bn (€1.58bn) at the end of May. Corrected for the liquidation of the three banks, the volume of loans contracted by 0.8% y/y – despite the 10% y/y rise in assets and the robust deposit base. Since last October, after the three banks were taken out of the banking system, the stock of loans decreased nominally by 6.7%.

The stock of deposits decreased by 21% y/y to MDL52.2bn (€2.33bn) at the end of May. But adjusted for the elimination of the three banks last September,deposits increased by 6.2% y/y.

Loans decreased to 50% of the banking system’s assets at the end of May, from 54% last year and 55% last October.