PRESS CONFERENCE
Statement by Mr. Ardian Fullani, Governor of the Bank of Albania, at the Press Conference following the Bank of Albania Supervisory Council's decision on the increase of the core interest rate

The Supervisory Council of the Bank of Albania, at its meeting of July 12, 2006, treated the monetary developments and the inflation performance verified over the first half of the year.

In June 2006, the sharp upward trend of annual inflation rate, verified over the two preceding months, was smoothed over. The annual inflation rate dropped to 2.4 per cent, compared to 3.1 per cent it was at end of May 2006.

The seasonal effect, which exerts pressure in terms of cutting the foodstuff prices, delayed during May, is estimated to have been compensated partly during June. However, the second quarter of 2006 recorded an annual rate higher than that of the same previous year period. This fact testifies the presence of added inflationary pressures during this period.

Other factors, beyond the seasonal ones, such as the mitigated appreciation of the lek against the euro, the upward trend in import prices, peak rise of oil prices and of raw materials, constitute the basis of inflationary pressure intensification in the economy during this period of the year.

Monetary indicators performance has been satisfactory. The monetary supply in the economy has grown at rates close to historical trends. According to data as of May, the annual growth of money supply, M3, resulted to 10.5 percent. The money supply structure tends to be shifted towards foreign assets.

The monetary expansion of January - May is completely a consequence of the private sector's demand for monetary assets, while the public sector's demand has had a reverse neutralizing effect. In May, credit to the economy reached to ALL 146.5 billion, recording a growth of 66.8% compared to the previous year. During 5 first months of 2006, credit has increased on average by ALL 5 billion a month or 30% more than in the previous year. During the first months of the year, the new credit extended was totally ALL 55 billion or about 33 percent more than in the previous year.

During the first half of 2006, the interest rates generally had downward trends in the ALL deposit market, in the primary Treasury bill market, in bonds market and in ALL credit market, while the interest rates in interbank market were stable.

The lek was characterised by appreciating pressures against the dollar during the first half of the year (as a reflection of world market developments) whereas it was relatively stable against the euro.

During the second half of the year, similar to the first half of 2006, the Bank of Albania has factorized, in the forecasts on inflationary developments in the economy, even the possible impacts that may derive from the materialisation of some risks, which it has made public a long time from now.

The Bank of Albania deems necessary to deal with these factors once more, highlighting the following as the most important ones:

Electricity price rise - Starting from July 2006, along the year, the inflation rate will be impacted upward, due to application of new tariffs for the consumed electricity.

The downward trend between interest rates in ALL and those in foreign currency - The global environment with rise of interests, has started to create incentives for changing the preferences of economic agents, particularly in terms of holding savings in foreign currency. This tendency appears in the increased ratio of foreign currency deposits to total deposits and in weakening the appreciating exchange rate trends. The exchange rate, though it continues to be appreciated in annual terms against the euro, during the latest months it recorded a moderation of the appreciation intensity. Different exchange rate behaviour from the typical seasonal behaviour of the preceding years would be immediately transmitted to inflation. As it is already known, the inflation impact channel (particularly the group of tradable goods), as randomly happening in most import-oriented countries, is very sensitive in cases of currency depreciation.

Continuous oil price rise - The peak values recorded lately for the oil and its sub-products prices constitute a potential risk to inflation. This becomes even sharper if it is taken into account the fact that the oil price in the country has exceeded the "critical" point, beyond which the business activity would be faced with obvious difficulties[1].

Agricultural price performance - The agricultural products prices have recorded a relatively different behaviour. During two last years, the prices of these products have been characterised by negative annual change rates, contributing to low inflation levels, while this year this performance seems somewhat different.

Rapid growth of credit to the economy - As in the previous year, even during the first half of 2006, a high growth of credit to the economy was evidenced. The rapid growth of credit, particularly of the consumer one, impacts on domestic demand rise, which would, in turn, impact on increasing inflationary pressures in the economy.

The way of realizing the budget deficit - The gradual rise of inflation during the first half of the year presents a more concerning development, if we take into account that it has happened under the conditions of a tightening fiscal policy. In compliance with the program of 2006, the budget deficit financed with domestic sources for 2006 is programmed at the value of ALL 23 billion, while currently the presence of a high excess of around ALL 11 billion continues. If all this large difference, even under the conditions of a possible reduction of the total programmed value, would be covered over the rest of the year, then besides pressures for liquidity, at a second moment, other pressures would be generated in terms of domestic demand.

Core inflation rise - Part of the above factors have a transitory nature. However, the upward trend of the core inflation supports the general rise of inflationary pressures in the economy, without excluding their existence on the demand side.

Taking into account all the earlier-mentioned risks, based on the latest developments and on the inflation forecasting for 12 consecutive months, the Bank of Albania deems that the probability of occurrence of one or some of the negative above-mentioned effects has increased. This would create premises for the annual inflation rate to fluctuate around the extreme tolerance values of the Bank of Albania target during the coming period.

Under these circumstances, further to recent attitudes, based on numerous analyses and empirical models, the Supervisory Council of the Bank of Albania decided to raise the weekly repurchase agreement rate by 0.25 percentage point, from 5 percent to 5.25 percent.

This rise intends a better control over the demand pressures, a better accommodation of shocks that come from the supply side, a better stabilization of exchange rate and a control on inflationary expectations.

This decision will serve to signal the institutional will of the Bank of Albania for controlling inflation. The Supervisory Council of the Bank of Albania believes that the low inflation rates that characterise our economy are undoubtedly a prominent accomplishment, in full compliance with the advanced theoretical thought, with best international practices and experiences and with nominal Maastricht criteria.

The Supervisory Council of the Bank of Albania deems that this is an appropriate decision, taken in due time, and a forward looking one. Our decision-making is based on a prudential analysis of potential risks that are in the horizon. The decisions deriving from these analyses aim at orienting the future towards programmed levels.

This is a modern concept, which aims at anchoring all the inflation expectations around 3 percent, with a tolerance band of +/- 1 percent.

To this end, the Bank of Albania will continue to be vigilant in all directions, naturally making the maximum efforts so that even in the future, its decisions are in compliance with the primary objective assigned by law, to sustain a stable economic development.

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[1] According to estimates, based on the business confidence index (IBB, Q1-2005), beyond the price of 110 lek/liter, the business activity becomes more sensitive to negative effects of oil price rise.