Polish central bank in two minds over rate cuts
CPI inflation fell into negative territory in July, and the market expects the Polish monetary authority to cut rates, but currency concerns, relatively buoyant growth and supply-side drivers of disinflation argue for caution.
It’s a reminder that amid the competitive global monetary-easing cycle, among developed economies, Poland’s historically low benchmark rate of 2.5% positively reeks of yield compared with the European Central Bank, Bank of England and the Czech National Bank, at 0.15%, 0.50% and 0.05%, respectively.
|A rate cut could weaken
With the crisis in Ukraine undermining growth across the region and with inflation stubbornly low, the Narodowy Bank Polski (NBP) is coming under increasing pressure to act. For most market participants, it has now become a question of not if but when and by how much.
CPI inflation fell into negative territory in July, to -0.2%, and while core inflation is higher, at 0.4% year-on-year, it remains below the 1.5% to 3.5% target.
Poland’s experiences with high inflation in the 1990s arguably mean the monetary authority is institutionally more comfortable with inflation undershooting the target than overshooting, while falling food prices and EU-Russian goods have underscored the supply-side drivers of disinflation.
“We expect the recently introduced sanctions to deteriorate the economic picture in the nation further,” says Kamil Amin, currency strategist at Caxton FX. “Polish food exporters will be seriously hurt by the Russian import ban, creating an over-supply of food in the nation, which will almost certainly weigh in on domestic food prices.”
He therefore believes the NBP should act. “It would be in the best interest of the Polish central bank to abandon its current neutral stance and ease policy further by at least 50 basis points,” he says. However, it might be prudent to stagger the cut over a three-month period, allowing it to factor in November’s inflation data.
Charles Robertson, chief economist at Renaissance Capital in London, agrees a 50bp rate cut is imminent, having been priced in by bond and money markets. He also believes it is likely to come in two sets of 25bp cuts – especially given Hungary has opted to make its cuts in 10bp increments.
Many expect the NBP to defer the decision by at least one more month and leave rates unchanged in September. The NBP has traditionally been cautious about acting, for example, in 2011 when it was caught off-guard by the abrupt depreciation of the zloty in the depths of pessimism over global growth prospects. “The question is have they learned their lesson?” asks Robertson.
However, Barclays is less convinced. “While we find the case for cuts relatively compelling, we remain unconvinced that the NBP will necessarily have to cut further,” says Daniel Hewitt, senior emerging EMEA economist at Barclays, in a report. “We think the NBP will keep its 2.5% policy rate on hold in September and await further evidence before making its decision in Q4.”
The market seems to be gravitating towards the imminent-action camp, leading to higher-beta Polish rates outperforming core markets.
“Our five-year PLN receiver versus EUR position in the Global EM Investor Portfolio has traded down to 195bp, going through our 200bp target,” says Morgan Stanley.
“It makes sense to receive rates in Poland, but positioning versus core markets provides a hedge amid arguably more stretched valuations and potentially unfavourable CPI base effects.”
Deutsche believes the rate cuts might be more aggressive still. “The market has priced in rate cuts of almost 75bp within next six months, though actual central-bank actions will depend on data flow,” says Arkadiusz Krześniak, chief economist at Deutsche Bank in Warsaw.
Formation of bubbles
Yet some on Poland’s monetary policy committee (MPC) remain fearful that further loosening will distort markets and risk the formation of bubbles, rather than promoting growth based on firm fundamentals.
However, there is little evidence of such distortions appearing as yet.
The NBP seems to be mainly worried about two things, says Krześniak. One is that action is unnecessary and that the economy will recover on its own. The second is the possibility that a rate cut will weaken the zloty.
However, the latter concern looks overdone, he says, given “the zloty has proven itself relatively resilient, even in the face of geopolitical risks in the region”.
While a weaker currency would boost exports and help increase inflation, the central bank’s fear is that a rate cut, in conjunction with the Ukraine crisis, might weaken the currency excessively.
“PLN stability is important as weaker PLN may adversely impact households’ and corporate balance sheets, increasing their FX liabilities,” says Krześniak.
“The main driver of zloty movements in the last few weeks has been the events in Ukraine,” he says. “If you removed that influence, the currency would be stable. So even if the MPC does cut rates in October, it wouldn’t be aggressive – you would still have sufficient rate differential between Poland and the eurozone, and the zloty would still be supported by inflows on the government bond market.”
Any PLN appreciation would tighten monetary conditions and encourage the NBP to cut rates to counterbalance this impact. Lower rates should also give any embryonic growth some much-needed momentum.
“If growth takes another drop downward and the NBP becomes concerned over its sustainability, it will be ready to cuts its policy rate by 50bp to 100bp to 1.5% to 2.0%,” says Barclays’ Hewitt, depending on core European growth trends.
GDP growth has been better than the monthly indicators and at 3.2% year-on-year does not appear to provide enough impetus to justify further rate cuts, says Hewitt.
“Recent weakening of the PLN has probably taken some pressure off the NBP to cut, even if only temporarily,” he adds.