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High inflation of secondary importance for the MPC

Interest rates remain unchanged

Today, the Monetary Policy Council decided to keep interest rates unchanged (with the NBP reference rate staying at 6.75%). We expected interest rates to be raised by 25bps, and this forecast was consistent with the market consensus. Our forecast was underpinned by the flash inflation data published recently which pointed to a continued and substantial growth of inflation in October (to 17.9% YoY vs. 17.2% in September). An additional argument in favour of a rate hike was the consistent rise in core inflation (excluding food and energy prices), which, according to our estimates, expanded to 11.1% YoY, up from 10.7% in September. Consequently, core inflation in Q4 will most likely run above the level expected in the July NBP projection, thus raising the starting point for the November projection.

High inflation of secondary importance for the Council

In the press release following the meeting, the MPC reiterated its assessment that “a further slowdown of GDP growth is forecast for the coming quarters, while the economic outlook is subject to significant uncertainty”. In our opinion, the Council’s modified assessment regarding the economic and inflation outlook is particularly noteworthy. According to the Council, “the anticipated downturn in other economies along with a monetary tightening policy pursued by key central banks will have a limiting effect on global inflation and commodity prices” and “will reduce Poland’s economic growth”. The Council also concluded that “given the strength and persistence of the current shocks that remain beyond the impact of the domestic monetary policy, in the short term inflation will remain high, and its return towards the NBP inflation target will be gradual”. The MPC reiterated that “further decisions of the Council will depend on incoming information relevant to inflation and economic activity, including the impact of Russia’s military aggression against Ukraine on the Polish economy”. Thus, the press release suggests that today’s decision should not be interpreted as concluding the monetary tightening cycle. However, the MPC’s explicit indication that, in the short term, inflation will remain high (which is a new element compared to last month’s press release), coupled with the decision not to hike interest rates at today’s meeting, suggests that high inflation is of secondary importance to the Council with the monetary policy’s primary focus being to prevent an excessive economic slowdown in the coming quarters. In other words, the tone of the statement issued after the MPC’s November meeting indicates that the Council now has a stronger focus on the deteriorating economic outlook.

NBP projection: inflation set to return to target as late as 2025.

In line with the NBP’s November projection, based on data available up until 21 October 2022 and assuming stable NBP interest rates, there is a 50% probability that in 2022 inflation will be in the 14.4 to 14.5% range (compared with 13.2 to 15.4% according to the projection from July 2022), 11.1 to 15.3% in 2023 (9.8 to 15.1%), 4.1 to 7.6% in 2024 (2.2 to 6.0%) and 2.1 to 4.9% in 2025. Thus, the mid-term inflation path expected in the projection was significantly revised upwards compared with the forecast presented in July. Such a profile of expected inflation suggests that the average annual inflation in 2023 will reach double digits and in 2024 will stand well above the MPC’s inflation target (2.5%), to return to the target as late as 2025. We believe that due to the impact of the assumptions regarding the duration of the Anti-Inflation Shield on inflation in 2023 (the projection most likely assumes the termination of the Shield in early 2023, which raises the forecast average annual inflation rate by approx. three percentage points), the inflation expected in the projection in 2024 deserves particular attention. Its relatively high level, combined with today’s decision not to hike interest rates, supports our assessment that the Council attaches more importance to the economic growth outlook than the level of inflation in the mid-term. The GDP growth rate expected in the projection will, with a 50% probability, be in the 4.3 to 4.9% range in 2022 (vs. 3.9 to 5.5% in the July projection), -0.3 to 1.6% in 2023 (0.2 to 2.3%), 1.0 to 3.1% in 2024 (1.0 to 3.5%) and 1.8 to 4.4% in 2025. Therefore, the projection outlines a scenario of near-zero economic growth in 2023 with a gradual acceleration in the following years.

Is this the end of the hike cycle?

Today’s second consecutive decision of the MPC to keep interest rates unchanged is consistent with the reluctance to keep tightening the monetary policy expressed in public statements by the NBP President and some MPC members despite the persistent and high inflation that is unlikely to go back to the inflation target in the monetary policy transmission horizon. In our opinion, this decision suggests that the Council has likely ended the interest rate hike cycle, despite no declaration to that effect in the press release. Against the background of a sharp economic slowdown that we are expecting, as reflected in our forecast of a temporarily negative annual GDP growth in Q1 2023 (-1.0% YoY), a further slight increase in inflation expected in November and December may not be a sufficient grounds for the Council to support another rate hike. This, in turn, means that even if inflation rose substantially in Q1 2023, if the so-called Anti-Inflation Shield is terminated (which, however, is not our baseline scenario), given an increasingly sharp economic slowdown, the MPC will not raise interest rates in the coming months, thus ending the monetary tightening cycle. The NBP President’s conference scheduled for tomorrow will shed more light on the short-term outlook for interest rates.

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