PRESS RELEASE
Today, on 26 October 2011, the Supervisory Council of the Bank of Albania reviewed and approved the Monetary Policy Report for the third quarter of 2011. Based on the analysis of Albania’s latest economic and financial developments and following dis

Today, on 26 October 2011, the Supervisory Council of the Bank of Albania reviewed and approved the Monetary Policy Report for the third quarter of 2011. Based on the analysis of Albania's latest economic and financial developments and following discussions on the performance outlook, the Supervisory Council of the Bank of Albania decided to leave the key interest rate unchanged at 5.00%.

(Let me now proceed with an overview of current and expected economic developments, as well as main issues discussed at today's meeting.)

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Overall, the Albanian economy had a positive performance in 2011, although in the presence of an unfavourable external environment.

 Domestic economic activity posted growth and some of the main macroeconomic and financial balances are controlled and have further improved.

Nevertheless, certain challenges have had their impact on the Albanian economy. More specifically, during the last two years, economic growth has been characterised by hesitating behaviour of economic agents towards consumption and investment. Similarly, reassessment of risk in financial markets has been coupled with added prudence and heightened risk premiums in domestic and international credit markets. Furthermore, high prices of oil, food and other products in global markets have led to higher import prices for Albania along with strong inflationary pressures during the first half of the year. Finally, the increased attention of financial markets towards public finance health has limited the possibility of fiscal authorities to pursue strong and stimulating policies.

 All these factors are reflected in economic growth rates, bringing them to below the potential level and creating spare capacities in the economy.

Moreover, these challenges have identified the need to continue with structural reforms and pursue prudent macroeconomic policies. Structural reforms, at macro and micro level should be oriented towards increasing the competitiveness of our labour force, products, and services in the global market. In addition, these reforms aim at enhancing foreign interest on the Albanian economy, as a business destination. Macroeconomic policies are facing a new reality, at the national, regional and international level. They should not, however, shift the focus away from maintaining macroeconomic and financial stability.

This stability controls long-term risk premiums and is a prerequisite for stimulating sustainable investments in the economy.

Analysing these issues and coping with these challenges has been the focus of the Bank of Albania's work during 2011.

In following paragraphs, I will present a more detailed overview of economic developments in Albania, focusing on inflation performance and Bank of Albania's work to accomplish its mandate, to maintain price stability.

In the third quarter, average annual inflation rate was 3.2%, down by 0.9 percentage points compared to the rates of the first half. Annual inflation had also pursued a declining trajectory during the second quarter but it appeared more pronounced during the third quarter.

This trajectory is determined primarily by the reduced contribution of food items inflation, as a result of price increase slowdown for these goods in international markets. Additionally, the increase of domestic agricultural products supply beyond the seasonality that characterises this period had an impact on the reduction of food items inflation. Furthermore, this quarter evidenced the full cancelling out of the effect of administered price increase from a year ago.

Inflation, in 2011, was mainly affected by supply shocks, which are materialised in higher import prices. As expected, this effect was more moderate in the third quarter. Its downward dynamic was shaped mostly by more moderate growth rates of raw materials and commodities in international markets. Supply shocks were balanced by downward pressures originating from aggregate demand. The Albanian economy continued to grow in the second and third quarters of the year; however, it continues to operate below its potential.
Below-potential growth has conditioned partial utilisation of production capacities and has prevented the creation of wage-inflation spirals. Furthermore, controlled expectations of economic agents on inflation have kept second-round effects at minimum levels.

Public sector demand and foreign demand continued to support economic activity, although at a more moderate rate. Meanwhile, private sector demand had positive but slow positive rates. Private consumption rates remain contained, influenced by insecurity for the future and hesitating consumer behaviour. Nonetheless, employment indicators stabilisation and increased aggregate disposable income suggest a growing potential and potential consumption growth during this period.

Private investments remain slow. Increasing foreign demand has supported the expansion of investment in the industry sector, but slow domestic demand has not favoured investment increase in services and construction sectors. Below-average capital utilisation rates, which is present almost across all the sectors of the economy, is expected to dictate low demand for investments in the near future as well.

Public sector demand stimulated economic growth this year, but its contribution has been declining since the first quarter. The performance of this aggregate demand element has been dictated by the conduct of fiscal policy, which, although on the stimulating side for 2011, has been more prudent over the last two quarters. Budget deficit at the end of the first months of the year was ALL 30.7 billion, remaining almost unchanged for three consecutive months.

In GDP terms, it is estimated to be at 3.1%, or 0.5 percentage points higher than a year earlier. Budget deficit performance has been defined primarily by the slowdown of public spending, while public revenues retained slow growth rates. Public spending and revenues growth at the end of the first nine months of the year was 3.5% and 1.0%, respectively.

Foreign demand continued to support Albania's economic growth. In real terms, net export deficit in the second quarter narrowed compared to a year earlier, materialising in a positive contribution of this component to aggregate demand. Latest data on foreign trade suggest a similar trend for the third quarter as well. Trade deficit in July and August narrowed on average annual terms by 0.2%, as a result of increased exports and slight slowdown of imports. Exports increased on average by 31.7% during July-August.
Good performance of exports, beyond the positive impact of temporary factors related to energy sector, is stimulated by exports of processed goods and mineral raw materials. Imports marked an average annual rate of 8.2%. Regardless of positive developments, reduction of the current account deficit demonstrates the need to continue with structural reforms in order to enhance domestic products competitiveness.

Monetary indicators confirm the estimation for contained inflationary pressures in the Albanian economy. Expansion of money supply is considered to be in compliance with the economy's demand for real money. Annual M3 growth was 10.6% in July-August, retaining its rates noted during 2011. Private sector demand for monetary assets pursued the rising trend of previous months. Lending to the private sector was up by 12.6% in July and August, or about 1.1 percentage points higher than average rates recorded in the second quarter of the year.
This growth relied primarily on private businesses demand for funding, while lending to households is also pursuing a rising trend. Annual growth rates for lending to households settled at 5.7% at the end of August, from 1.5% at the end of last year.

Bank of Albania analyses suggest that the moderate credit growth is primarily due to lower demand by the economy for credits. This stance is confirmed by business surveys, which display a weak investment inclination as well as by the reduced number of credit applications to commercial banks. Against this setting, the banking system is liquid and well capitalised to conduct its financial intermediation activities. In response to the monetary policy of the Bank of Albania, credit interest rates have reached their historic low. Nevertheless, the banking system has added its prudence as regards lending, with more critical assessment of business plans and tightened requirements for collateral.
This approach is a reaction to the insecurity about the economy in general or its specific sectors and reflects a more prudent development model of crediting and banking business. In the long run, it will yield a more sustainable growth for the Albanian economy and will guarantee a solid and reliable banking system.

Financial market developments reveal low liquidity and inflation premiums. Trade volume in the interbank market increased further, while, in the presence of a good liquidity situation, interest rates in this market followed the decrease of the key interest rate and displayed low volatility. In respect of time lags in the monetary policy transmission mechanism, the decrease of interest rates is expected to be transmitted also in the deposit and credit market. Bond yields retained their rates during the second quarter, in the presence of moderate government demand for short-term funding.

Looking ahead, our estimations and projection suggest continued economic growth for the rest of the year. Foreign demand is expected to support aggregate demand, but at slower rates compared to the first half of the year. Domestic demand performance remains pivotal to economic growth, while contribution of public stimulus is expected to moderate even further, as a result of the need to retain stability of fiscal indicators. Under these circumstances, private sector demand will condition the size and velocity of domestic demand recovery in the future.

Performance of fundamental factors that define private demand suggests that there will be a potentially better performance of consumption and investments in the economy compared to the estimated insofar materialisation.

Bank of Albania deems that, within the parameters of macro and microeconomic health, space exists for a more rapid growth of consumption and investments as well as a more realistic behaviour of economic agents towards projections for the future. The Albanian economic outlook remains sound; development policies and further structural reforms will free new development potentials, which need to be explored far-sightedly and attentively by the private sector.

Analysing the factual and expected inflation performance, in September, the Bank of Albania eased the monetary conditions, lowering the key interest rate by 0.25 percentage points down to 5.00%. The easing of monetary conditions, in addition to maintaining price stability, enables a higher support to internal demand.

In the absence of unexpected shocks, inflationary pressures appear to be downward in the medium term horizon. The reduction of foreign price effects on inflation and the impact of negative output gap make the inflationary pressures balance to remain controlled and downward during the time span of monetary policy action. Inflation is expected to range around our target in the medium run. It will be under the balanced influence of internal and external inflationary pressures. Aggregate demand is expected to remain below the economy's potential, thus carrying forward the negative output onto the upcoming period. Subsequently, inflationary pressures originating from the demand side will remain contained. Additionally, foreign price effects will continue to be present in consumer prices performance and is expected to pursue its downward trend.

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At the conclusion of discussions, the Supervisory Council decided to leave the key interest rate unchanged at 5.00 %. The monetary policy position in the future will aim continuously to adjust monetary conditions with a view to respecting our objectives, in the presence of downward inflation trends. Without affecting price stability and external balances of the economy, the clarification of the situation in the euro area over the coming days and confirmation of our expectations on Albania's economic performance may create space for further easing of the monetary policy.