UPDATE 2-Romania, weighing inflation vs growth, holds rates

Mon Jan 7, 2013 9:53am EST

* Keeps rates at record low 5.25 percent

* Balances inflation, weak currency with slow economy

* Domestic demand, euro zone to keep economy under pressure

By Luiza Ilie

BUCHAREST, Jan 7 (Reuters) - Romania's central bank held interest rates unchanged at a record low on Monday, seeking to balance above-target inflation and a still weak currency with an economy on the brink of recession.

While neighbours such as Poland, the Czech Republic and Hungary have cut rates to help their economies, Romania -- the European Union's second-poorest member and relying on an International Monetary Fund deal -- has had to keep a premium to maintain investor interest.

The benchmark interest rate remained at 5.25 percent, as had been forecast by all 13 analysts in a Reuters poll.

The central bank halted a rate cutting cycle in May 2012 due to persistently high inflation -- which was an annual 4.6 percent in November, versus a 2-4 percent target -- and a series of government changes that sent the leu currency to a record low.

Governor Mugur Isarescu said the central bank expected annual inflation to slow to within a new and lower 1.5-3.5 percent target band sent by the bank by the end of 2013 but the economy would continue to struggle.

"The feeble dynamics of industrial production and retail trade, as well as the protracted euro area recession entailing adverse effects on Romanian exports, suggest the persistence of the negative output gap," Isarescu told reporters.

Since May, the central bank has left rates unchanged but introduced market liquidity controls to tighten policy, and the leu has regained some ground since the leftist government secured a new mandate in a Dec. 9 election.

The leu traded about 0.2 percent firmer against the euro from Friday's close.

IMF DEAL

Romania's economy suffered after the global economic crash ended a credit boom in 2009 and it had to take drastic measures under an IMF deal, raising taxes and cutting spending to put the country on a more even footing.

But that deepened recession and the economy is barely recovering and on the edge of another contraction having shrunk 0.5 percent in the third quarter of 2012 compared with the prior three months.

After his election win, Prime Minister Victor Ponta has a mandate to conclude a new deal with the IMF to replace a 5 billion euro agreement expiring in March, an important reassurance to foreign investors that Romania will keep tight fiscal policy.

The prospect of a new deal has helped bring down borrowing costs, which have fallen nearly 50 basis points on three year paper.

But the currency remains within about 5 percent of its record low against the euro and the threat of more political instability -- with Ponta having to work with his rival, President Traian Basescu -- limit the central bank's room to manoeuvre.

"The next move may well be a cut, but inflation has to drop closer to the target before the NBR can begin cutting," said Barclays Capital economist Daniel Hewitt.

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