PRESS RELEASE
Governor Sejko: Statement to the Press Conference on the Monetary Policy Decision of the Supervisory Council of the Bank of Albania 3 October 2017

The analysis of available data indicates that the economic activity in Albania continued to improve, while inflation declined in July and August. The divergence between the performance of economic activity and the performance of inflation appears to reflect the effect from supply-side shocks, which are expected to have only short-term effects on inflation. On the other hand, monetary and financial conditions remain stimulating, underpinning growth of demand, further improvement of the capacity utilisation rate and the return of inflation to target within the medium-term horizon.

In a more detailed analysis, annual inflation declined in the first two months of the third quarter, standing at 1.6% in August. The decline in inflation reflected a slowdown of food prices, especially unprocessed food, whereas the other groups did not show notable volatility. Taking into account the new developments in inflation, our projections for the average inflation in 2017 have been revised slightly downward, from 2.2% to 2.1%.

The concentration of the decline in inflation in certain segments of the basket, and the correlation of this decline with the dynamics of food prices inflation in the region, the exchange rate appreciation, and the increase in the domestic supply for these products lead us to think that the slowdown in inflation reflects the effect of short-term supply-side shocks.

Against these shocks, the overall balance of factors having a longer-term impact on inflation remains unchanged: (i) capacity utilisation rate has been upward; (ii) inflation expectations remain relatively stable; and, (iii) inflation in trading partners is projected to be upward in the period ahead.

Economic activity at home continued to grow in the second and third quarters of the year. Based on INSTAT data, economic growth was 4.06% in the second quarter, driven by both domestic and external demand.

- The increase in employment and income, the improvement of financing conditions and the improvement of confidence in production sectors have supported the expansion of consumption and private investments.

- The fiscal policy continued on the consolidation path, reflected in positive values of the budget balance. As at the end of August, the budget balance resulted in ALL 0.1 billion surplus, reflecting the annual increase by 6.7% of public revenues and by 12.4% of budget expenditure. Yet, the deceleration of the fiscal consolidation compared to the previous year generated a positive impulse to aggregate demand growth, especially in the first half of the year.

- The improvement in foreign economies and the added focus on Albania as a tourism destination has boosted the demand for Albanian exports in goods and services over the first eight months of 2017.

The aggregate demand growth has fuelled a more complete utilisation of production capacities in Albania. According to INSTAT data, employment continued to rise, whereas the unemployment rate fell to 13.9% in the second quarter. Likewise, data from business and consumer surveys suggest that the utilisation rate of businesses production capacities has been upward, although this rate remains below the historical highest level. Overall, the Bank of Albania finds that the Albanian economy continues to operate below its potential, but the gap has been narrowing.

Financial markets operate under calm conditions and interest rates and financing conditions sustain the achievement of our target. The accommodative monetary policy stance applied by the Bank of Albania has played a decisive role in this regard. The pass-through of the monetary stimulus to the financial market is reflected in lower interest rates and reduced risk-premia. These developments have facilitated the costs of servicing existing loans and have stimulated credit growth in the domestic currency. In annual terms, credit to the private sector grew by 3.1% in August, driven almost entirely by the annual growth by 9.6% in the lek credit portfolio.

Banking system soundness indicators improved. They show good capitalisation and liquidity levels, and decline in the level of non-performing loans. As a result of the measures taken to reduce the level of non-performing loans, their ratio to total loans was lowered to 15.14% in August, the lowest level since 2011. The non-performing loans ratio is downward for almost all banks in the system, and reflects not only the regulatory requirement for writing them off, but also the repayment of loans by the private sector. The improvement in the banking system's balance sheet, the perceived reduction of the credit risk and further improvement of the business climate are expected to contribute to better bank credit supply in the medium term. Coupled with the expected recovery of credit demand, these developments are expected to be reflected in faster credit growth in the period ahead.

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Our updated analysis and short-term projections are in line with the previous expectations on economic and monetary developments in the medium term. The slowdown in inflation in the last two months does not create significant divergences in its trajectory for the period ahead. The return of the economy to potential and the gradual absorption of unutilised capacities are expected to be associated with the gradual increase in inflation rates. Inflation is expected to return to target within 2018.

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Expected economic and monetary developments suggest that the current monetary policy stance is adequate. Achieving the inflation target requires implementing an accommodative monetary policy stance over the medium-term horizon, to offset the short-term decelerating effect from the exchange rate and to sustain economic growth.

Taking into account these circumstances, the Supervisory Council decided to:

• Keep the monetary policy rate unchanged, at 1.25%;
• Keep the interest rates for the overnight deposit and lending facilities, unchanged at 0.25% and 2.25% respectively.

Judging on the available information, the Supervisory Council deems that the intensity of the monetary stimulus will not be diminished before the second quarter of 2018. In any case, the normalisation of the monetary policy will be prudent, aiming at guaranteeing price stability in the medium term and supporting the stability of economic growth.

Also, in response to continued supply-side shocks on inflation and reflecting the shift of the balance of risks to the down side, the Supervisory Council affirms that it stands ready to take all the necessary measures for guaranteeing the sustained return of inflation to target, within a reasonable horizon. Depending on the intensity of shocks or materialisation of various risks, these measures may range from a slower normalisation of the monetary policy to a potential increase in the intensity of the monetary stimulus.