Economy emerging from abyss
According to our ultra-high frequency index, economic activity stood at 76% of an average pre-crisis month in March, at 37% in April, before rising towards 46% in May. We expect an economic contraction of -4.7% for the entire 2020 and a recovery that could take 5-6 quarters before reaching pre-crisis levels, assuming no second wave of the pandemic. The risk balance is skewed towards a slower recovery and the outlook for 2021 heavily depends on the fiscal policy stance after the general elections and subsequent measures to bring the budget deficit under control and avoid rating downgrades.
We forecast inflation at 2.8% by end-2020 vs. 4.0% at end-2019, as the Covid demand shock and falling oil price take their toll. The current account deficit is seen narrowing to -3.5% of GDP in 2020, from -4.7% in 2019. The central bank is lagging peers both in delivering aggressive rate cuts and the size of the quantitative easing program. Keeping a relatively high interest rate differential suggests that the EUR/RON continues to be an important aspect of the NBR reaction. Some monetary easing might come via loosening liquidity management if the FX is stable.
The exchange rate remains an important factor in the NBR reaction, as suggested by the decoupling of the money market rates from the implied FX forward yields. The NBR pledged to keep providing liquidity to the market via bilateral repo auctions and bond buying on the secondary market. The central bank also mentioned its intention to keep FX reserves at an ‘optimal level’, linking the interest rate outlook to the potential FX depreciation pressures. We see only one more 25bp rate cut to 1.50% in 4Q20 and more easing afterwards via liquidity management.
The shape of the RON yield curve suggests that the climax of the pressure on the long-end, a segment largely owned by offshore investors, is behind us. The 10Y-3Y ROMGBs spread dropped towards 80bp in May, from 120-130bp in the second half of March, due to the steeper decline of long-dated yields. The current spread nevertheless remains above the average of 60bp in January-February. The risk of a new bout of weakness for RON sovereign debt should not be ruled out and could be linked to the government plans regarding the 40% pension hike.