The NBP will finance a subsequent bazooka

Another interest rate cut

The Monetary Policy Council took today a surprising decision to cut interest rates by 50 bp, which means that the reference rate will go down from 1.00% to 0.50% and the deposit rate, determining interest on commercial banks’ one-day deposits at the NBP, from 0.50% to 0%. According to the assessment presented in the press release after the meeting, the main reason for the cut was the continuing risk of inflation falling below the MPC inflation target in the monetary policy transmission horizon, due to a stronger than expected impact of the COVID-19 epidemic on the economic activity in Poland (at a joint press conference with the Prime Minister, the NBP Governor has even mentioned the “threat of deflation”). In the opinion of the MPC, in the short run, the drop in economic activity can be “very sizable” and will be accompanied by a deteriorating situation in the labour market and a fall of households’ disposable income. In the Council’s view, further ahead economic activity can be expected to gradually recover, supported by fiscal measures introduced in Poland and many other countries as well as “strong macroeconomic fundamentals of the Polish economy”.

NBP will purchase government-guaranteed debt securities

In accordance with the statement, the NBP will be purchasing government-guaranteed debt securities, which is the extension of the currently implemented government bond purchase program. The purchase of the government-guaranteed securities by the NBP should be perceived as a part of the “financial shield” program, announced today by Prime Minister M. Morawiecki, in continuation of the measures taken by the government so far with a view to reducing the negative impact of COVID-19 on the functioning enterprises and the labour market. According to the Prime Minister’s declaration, under the “financial shield”, the companies meeting certain conditions (continuation of operations and maintenance of employment) will receive from the Polish Development Fund (PFR) a 3-year support, limited as to amount, in the form of financing of activity, where, after one year, 75% of this support may be treated as a non-repayable subsidy. It means that the NBP, purchasing the PFR bonds, will finance this program, which the government estimates at ca. PLN 100bn (ca. PLN 25bn for micro-enterprises employing up to 9 employees, ca. PLN 50bn for small and medium-size enterprises employing at least 250 employees). The financial shield announced today strongly supports our forecast of unemployment in Poland in 2020-2021 period, in which the rate of registered unemployment in Poland will not reach a double-digit level (see MACROmap of 6/4/2020). What is important, due to the transfer of debt to the PFR, the thus structured shield will not contribute towards increasing the debt of the public finance sector. In addition, the scale of the liquidity facility (ca. 5% of GDP) signals that the quasi-fiscal stimulus in 2020 will be significantly bigger than the one previously announced by the government. This fact will be reflected in our revised macroeconomic scenario to be published in the next MACROmap.

The MPC is only a step away from the quantitative easing of monetary policy

Especially noteworthy in the statement after the MPC meeting is the fragment with new justification for the purchase of debt securities, including the government-secured securities. According to the MPC it is “enhancing the impact of the NBP interest rate cuts on the economy, i.e. strengthening the monetary policy transmission mechanism” (which is surprising in the light of the insignificant role of changes in long-term interest rates in the monetary policy transmission mechanism in Poland in contrast to many advanced countries). It means that the MPC has started to treat the purchase of debt instruments not only as an exercise changing the structure of liquidity in the banking sector and increasing the liquidity of the secondary market of treasury bonds (see MACROpulse of 17/3/2020) but as a separate measure aimed at strengthening aggregated demand in the economy. This view is supported by another fragment of the statement in which the MPC declares that the undertaken measures are aimed at “easing financing conditions in the economy and mitigating the negative economic impact of pandemic”, which contributes to “recovery in domestic economic activity after the abatement of current disturbances”. In addition, due to the aforementioned insignificant role of changes in long-term interest rates in the monetary policy transmission mechanism in Poland, the wording quoted above can, in our view, be interpreted as the MPC’s acceptance of a possible further significant weakening of the PLN exchange rate.

We therefore believe that the MPC-announced extension of the range of unconventional monetary policy instruments brings it substantially closer to quantitative easing. A factor which distinguishes the MPC measures from the “canonical” form of quantitative easing of monetary policy remains non-zero interest rate meaning the necessity of absorbing the liquidity consequences of the purchase of debt instruments.

Rate cut is negative for PLN

Today’s MPC decision and the text of the statement after the Council meeting are slightly negative for PLN. In addition, the rate cut in March and April by a total of 100bp took place before the publication of the macroeconomic data for March, which to a certain extent will reflect the impact of the introduced restrictions on the economic activity. This suggests that amid long lasting administrative restrictions of the economic activity due to COVID-19 and the accompanying expected sharp decrease in demand in Q2, the MPC is prepared to cut interest rates to zero.

In the next MACROmap we will present our revised profile of interest rates.