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MPC still dovish despite hawkish projection

Interest rates and MPC’s bias remain unchanged

As we expected, the Monetary Policy Council (MPC) has not changed interest rates at its meeting today (the reference rate is 0.10%). In accordance with its press release, the MPC expects economic activity to recover in the coming quarters, but the further development of the pandemic in Poland and abroad remains the main source of uncertainty about the scale and pace of recovery. In this context, the MPC noted that the spread of new variants of virus had been driving up the uncertainty regarding the further course of the pandemic. Like in June, the present press release also emphasises a positive impact of economic policy measures taken, including the easing of the monetary policy, on economic activity, which in the MPC’s opinion will also be supported by global economic recovery.

The press release continues to include comments about the importance of PLN exchange rates for economic prospects (“the pace of the economic recovery in Poland will also depend on further developments of the zloty exchange rate”) and the NBP’s readiness to intervene in the foreign exchange market (“in order to strengthen the impact of the NBP’s monetary policy easing on the economy, the NBP may also intervene in the foreign exchange market. The timing and scale of the measures taken by the NBP will depend on the market conditions”).

In accordance with the press release, the NBP is going to continue to purchase government securities and government-guaranteed debt securities in the secondary market as part of the structural open market operations (the value of bonds purchased so far is PLN 135.8bn).

When assessing short-term inflation prospects, the MPC pointed out, just like a month ago, numerous supply-related factors, such as growing fuel prices and waste disposal charges and higher electricity prices, which, while being independent from the domestic monetary policy, would translate into inflation staying above the upper band for deviations from the inflation target (2.5% +/- 1 p.p.). In the MPC’s opinion, growing costs of running business amidst the pandemic caused by higher international transport charges and temporary disruptions in supply chains keep on adding to inflation. The MPC believes that the fading of those factors next year will drive inflation down and the “sources and the expected temporary nature of inflation exceeding the NBP’s target” as well as the “uncertainty about the persistence and scale of the economic recovery” support the status quo in the monetary policy.

The press release continues to include comments made in June which indicate that the likelihood of interest rate hikes in the coming months is low. Firstly, when emphasising the supply-related nature of inflation rise in Poland, the MPC referenced again the Monetary Policy Guidelines for 2021: “due to the macroeconomic and financial shocks, inflation may temporarily deviate from the target and even run outside the band for deviations from the target” and “the response of monetary policy to the shocks is flexible and depends on their causes and the assessment of persistence of their effects, including their impact on inflation developments.” Secondly, the MPC repeated in its press release a comment reading that the NBP’s monetary policy “stabilises inflation at the level consistent with the NBP’s inflation target in the medium term.” In our opinion, this means that the MPC expects inflation to return close to the target set by the MPC in the mid-term horizon, and that it is not necessary to tighten the monetary policy at the moment. Moreover, the continuation of structural open-market operations announced in the press release suggests that in the MPC’s opinion even a small adjustment to the unconventional monetary policy preceding possible interest rate hikes would be unjustified at the moment.

NBP’s July projection: Inflation close to the MPC’s target in Q2 2022

According to the July projection of the NBP prepared on the assumption of unchanged NBP interest rates, there is a 50-percent probability that annual price growth will be in the range of 3.8-4.4% in 2021 (vs. 2.7–3.6% in the March 2021 projection), 2.5-4.1% in 2022 (vs. 2.0-3.6%) and 2.4-4.3% in 2023 (2.2-4,2%). This means that based on the projection in 2021-2023 annual average inflation will most likely run well above the MPC’s inflation target of 2.5%, although below the upper limit for acceptable deviations from the target (3.5%). At the same time, GDP growth is projected to be, with a 50-percent probability, in the range of 4.1-5.8% in 2021 (vs. 2.6-5.3% in the March projection), 4.2-6.5% in 2022 (vs. 4.0–6.9%), and 4.1-6.5% in 2023 (4.0–6.8%). The inflation projection suggests that the years 2021-2023 will see economic growth close to 5%, which is in line with our expectations.

The projection indicates that inflation in Poland will stay well above the MPC’s inflation target in the mid-term. Such a scenario is inconsistent with the MPC's assessment, outlined above, that the NBP’s monetary policy stabilises inflation in line with the inflation target. This in turn means that a majority of MPC members acknowledge a material downward risk to the projected inflation path in the mid-term. The development of the pandemic in the coming quarters, which is hard to predict, may be one of the sources of that risk. Tomorrow’s conference of the NBP president may cast more light on the problem.

The annual average inflation in 2022 projected by the NBP is close to our forecast. In our opinion, projected inflation will drop in Q2 to just above the MPC's target, which will be an important argument for keeping stable interest rates in the coming months.

Interest rate hikes still far-off

Both the MPC’ statement following its meeting and the July inflation projections show that the MPC intends to keep stable interest rates for quite some time despite elevated inflation expected in the coming quarters. Although in his statement last week the NBP President admitted the possibility of monetary policy tightening to start this autumn at the earliest, we believe that this scenario is rather unlikely as the fourth wave of the pandemic in Q4 is very likely given a relatively low population vaccination rate in Poland. This assessment is supported by the opinion of a majority of the MPC members, included in the minutes of the MPC’s meeting in May, to the effect that interest rate hikes would only be reasonable after the pandemic is over and that the conditions necessary for monetary policy tightening include the consolidation of economic recovery and the appearance of a risk of excessive inflation driven by demand-related factors.

We maintain our scenario that the MPC will not change interest rates until the end of 2022. We believe that if, in line with our forecast, inflation falls to just above the NBP’s inflation target (2.5%) in Q2 2022, then the MPC members will be reluctant to tighten the monetary policy (see MACROmap of 05/07/2021). This argument is relevant in the context of a change in the composition of the MPC after the end of its current term of office (at the beginning of 2022). Even if MPC members are replaced by more hawkish ones, inflation close to the target will be an argument for such new MPC members to keep stable interest rates. We expect the reference rate to be raised for the first time, from 0.10% to 0.25%, in January 2023. We acknowledge the risk of materialisation of a scenario in which stronger wage and inflationary pressure, and consequently a slower return of inflation towards the target in 2022, would prompt the MPC to start interest rate hikes in H1 2022, after the fourth wave of the pandemic has come to an end.

In our opinion, the press release following today’s meeting of the Council is slightly negative for the PLN and for yields on bonds.