Romania’s headline inflation accelerated to 5.4% y/y in May from 5.2% y/y in April, apparently exceeding the central bank’s expectations and coming close to analysts’ pessimistic scenarios. 

More than half of the inflation (3.2pp) was generated by higher fuel, energy and tobacco prices, though inflationary expectations are contributing as well. 

The surge in consumer prices fuels expectations of a more hawkish central bank stance in the coming months, although the views on the timing of the interest rate hikes differ. Under the baseline scenario envisaged by local banks, the policy rate would rise by 1pp by the end of the year from 2.5% at this moment. But even at 3.5%, the monetary policy would still look dovish in the economic overheating context and further hikes are foreseeable in 2019.

In its latest move, Romania’s central bank on May 7 raised the benchmark interest rate by 0.25pp to 2.5%. The bank has now raised rates three times this year, by a total of 0.75pp, to tame inflation. 

Politics eventually played a relevant role in the bank’s monetary policy and further deterioration of the situation will force the monetary authority (until now supportive of the government to a certain extent) to react to excessively loose fiscal policies. Gradual currency weakening paralleled by rising monetary policy rates will predictably alleviate the BoP pressures, though.

Speaking of price dynamics in May, 15.6% higher fuel prices contributed 1.25pp to the overall 5.4% y/y inflation. The 17% higher y/y electricity prices contributed another 1pp. The price of natural gas also increased by some 10% y/y with an impact of 0.34pp on the overall consumer price inflation. Tobacco products (9% more expensive than last year) contributed 0.57pp to inflation as well. A mix of administered and energy prices, exogenous to the monetary authority, have thus pushed up inflation to the highest levels in recent years.

But roughly half of the inflation (and this was a significant 2.7pp — above the 2.5% target inflation level) was generated by market prices and, in principle, by rising inflationary expectations driven by visible signs of overheating and concerns related to a hard landing.