“We are expecting BNR to raise interest to 8 percent against a backdrop of data linked to inflation and the evolution of the exchange rate,” reports the document made available to Business Standard. Economists of the Dutch bank further added that there are more reasons for BNR to raise the interest rate than to leave it at its present level. “BNR officials have every right to be concerned as long as the consumer price index exceeds the targeted level, and as the price of food and oil increases. In such a sensitive environment, BNR cannot afford to make a wrong move or put its hopes in a good agricultural yield,” added the ING document. Nevertheless, a harsher monetary policy is insufficient alone to bring inflation back in line with BNR’s target, and corresponding fiscal policies are also needed. However, it is unclear what will be the final decision of BNR’s Board of Directors today. What is certain though is that a rise in the interest rate will have a limited impact on demand (the most powerful monetary policy channel now being the rate of exchange), while a powerful appreciation of the leu would endanger the current account deficit, already at a worrisome level.

Yet another consideration in today’s central bank decision will be the fact that 2008 is an election year, which could well mean that BNR will be left on its own to battle inflation. “The approval of the 2008 budget is a first sign in this direction,” indicated the study by ING Bank economists, who believe that BNR will revise its inflation goal upward, to 4.3 percent from 3.8 percent. “We do not exclude the possibility that BNR will resort to the exoneration clauses, as two of three targets are missed. This is all the more possible as this year’s budget is based on a 2.7 percent deficit of GDP, and we estimate this will be 3.2 percent due to electoral expenses,” continued the study in question.

There are similarly reasons not to raise the monetary policy interest rate. “The interest rate channel influences prices through the exchange rate of the leu, rather than by a tempering of demand. A rise in the interest rate would appreciate the leu, which would affect competitiveness and lead to a rise in imports, thereby deepening the current account deficit. It is likewise very difficult to predict the consequences of a possible increase in the interest rate on the lending sector and the influence this might have on inflation,” according to the Dutch bank’s economists.