ALBANIA Economic Analysis

March 2011

By Dimitrios Shistohilis

 Growing concerns over inflationary pressures have seen Albania begin its monetary tightening cycle at its March meeting, raising the key repo rate by 25 basis points to 5.25%. We believe that high global commodity prices, continued feed through effects from the depreciation of the lek, and strong demand-side price pressures will see inflation spike higher, spurring further hikes by year end. As such, we are revising our end-2011 rate forecast to 5.75%, from 5.25% previously.

Albania's central bank, the Bank of Albania (BoA), raised its key two week repo rate by 25 basis points (bps) to 5.25% at its policy meeting on March 23, the first rise in the benchmark borrowing rate since November 2007. The rise in rates by the BoA comes on the back of growing concerns over accelerating consumer price inflation and represents the start of a monetary tightening cycle for the country, in our view. Going forward, we expect inflation to continue to ticking higher over the course of the year before moderating somewhat to post a 4.0% year-on-year (y-o-y) rise by end-2011.

Data released by the BoA show the country's consumer price index (CPI), taking a leg upwards in February, rising by 4.4% y-o-y. This is above January's inflation print of 3.3% y-o-y and represents a month-on-month (m-o-m) acceleration of 2.3%. We believe that the bulk of inflationary pressures are being driven by higher commodity import prices and this is belied by the categorical breakdown of the headline CPI. Domestic food prices rose by 6.9% y-o-y, up from 4.4% in January while the cost of transport, which is heavily dependent on the cost of fuel, posted a y-o-y gain of 5.3%. Going forward, with uncertainty in the Middle East and North Africa (MENA) region set to rumble on for the foreseeable future, keeping global commodity prices (especially oil) elevated, and this will continue to push inflation higher in Albania.

We also believe that the headline CPI print is being driven higher by delayed pass through effects from prior depreciation in the value of the Albanian lek versus the euro, against which the Albanian unit lost over 40% since Q308. Since the beginning of 2011, with the euro buoyed by the prospect of the start of the European Central Bank (ECB)'s monetary tightening cycle, the lek has lost a further 1.1% against its single currency counterpart. We believe that the BoA will be keen to stem further depreciation, which would exacerbate cost-push inflationary pressures from global commodity prices, by beginning its rate tightening cycle to support the currency and broadly maintain the interest rate differential between itself and the ECB.

Finally, we believe that greater demand side price pressures due to Albania's robust pace of economic growth will facilitate the BoA's decisions to raise hikes further, and this underpins our end-year rate target of 5.75%. Unlike its regional peers and indeed the bulk of Europe, Albania did not experience a protracted economic downturn, with real GDP contracting by just 0.5% y-o-y over a single quarter in Q409. Albania's economy has since accelerated strongly to post real GDP growth of 4.9% y-o-y in Q310 (the latest period for which data is available) and we estimate the economy grew by 3.7% in 2010. In 2011, we expect even stronger growth from the Albanian economy, forecasting gross domestic product to grow by 5.0% in real terms. Overall, we believe that the potential for rate movements is distinctly skewed towards the upside over the remainder of 2011.

Source BMI