A surprising interest rate hike

The MPC increases interest rates

Today, the Monetary Policy Council has taken a surprising decision to increase the interest rates. The reference rate and the lombard rate were increased from 0.10% to 0.50% and from 0.50% to 1.00%, respectively. The Council also decided to increase the required reserve rate from 0.50% to 2.00%. The passage saying that the NBP was going to continue its liquidity operations (i.e. purchasing government securities and government-guaranteed debt securities in the secondary market) has been removed from the press release, which also indicates that the monetary policy is being tightened.

The Council’s decision comes as a huge surprise in the context of recent statements made by some of its members, including in particular the President of the NBP, which showed their reluctance to quickly normalise the monetary policy, with the supply-side factors, including in particular growing energy prices, exerting a strong impact on inflation. Although we thought it could be possible that the Council might decide to raise interest rates this year, we did not expect the Council might do so before its November meeting, where they were supposed to familiarise themselves with the results of the new inflation projection.

The Council sees the risk of economy overheating

Particularly noteworthy about the press release following the Council meeting are the passages concerning the reasons behind the MPC’s today’s decision and inflation prospects, which make it possible to assess short-term interest rate profile more precisely. In fact, the surprising decision of the Council poses a question: was the increase just a one-off adjustment or is it the beginning of a series of interest rate hikes? In this context it is worth taking a look at the passage in the press release, in which the Council refers to the reasons behind the inflation rise that we can see these days. Apart from the supply-side factors referred to in previous press releases, which are independent from the domestic monetary policy, the Council pointed to a new factor stimulating inflation, namely the economic recovery, including rising household income. It indicates that the Council believes that the demand-side factors are driving the inflation increasingly up, and this requires a monetary policy reaction.

Another passage of the press release that is significant for monetary policy prospects concerns the inflation scenario. The Council has noted that even though the impact of some supply-side factors that are currently increasing inflation is expected to fade, “the rise in global prices of both energy and agricultural commodities observed in recent months may still increase price growth in the coming quarters.” Furthermore, in the Council’s opinion, “amidst probable further economic recovery and favourable labour market conditions, inflation may remain elevated longer than hitherto expected.” This opinion suggests that the Council considers the economic overheating in the mid-term perspective, i.e. the situation when the increasing wage pressure will cause inflation to remain elevated for a longer period of time, as highly probable. In the Council’s opinion, this, in turn, would carry the “risk of inflation staying above the inflation target in the medium term.”

A one-off hike or the beginning of a (mini-)cycle?

We believe that today’s decision was not a one-off adjustment of interest rates. We expect the Council to raise interest rates again by 25-50 bps in its November meeting, which might be the end of the mini-cycle of tightening of the monetary policy. Our opinion is supported by the results of the survey concerning the mechanism of transmission in the monetary policy. They show that increasing the NBP's reference rate by 40 bps will not reduce inflation significantly in the monetary policy horizon. Furthermore, today’s surprising decision of the Council seems to have been significantly affected by the pressure exerted by the current rate of inflation, which is growing quickly. In accordance with our forecast (see MACROmap of 04/10/2021), inflation will rise significantly in the months to come, reaching a local maximum of 6.7% YoY in January 2022, and it can be expected that the short-term inflation scenario that will be set in the NBP’s November projection will be similar to our forecast. In this case, most MPC members will most probably decide that it is necessary to react and tighten the monetary policy further. It is also worth noting that the passage saying that the NBP’s monetary policy “stabilises inflation at the level consistent with the NBP’s inflation target in the medium term” has been removed from the press release following the Council’s meeting. This suggests that the MPC does not believe the inflation target will be reached in the medium term despite today's interest rate hike. It will be possible to assess the interest rate prospects more precisely after tomorrow's press conference of the NBP President. In the next MACROmap, we will present our revised scenario for the NBP’s monetary policy.

In our opinion, the press release following today’s meeting of the Council will be positive for the PLN and for the yields on bonds.