MPC prefers stronger PLN to higher interest rate hikes

Another rate hike by 50bp

Today, the Monetary Policy Council has taken a decision to increase the interest rates once again. The NBP reference rate rose from 2.25% to 2.75%. The 50bp rate hike was consistent with the market consensus, but lower than we forecasted (75bp). At the same time, the MPC decided to increase the required reserve ratio from 2.00% to 3.50%, which can be interpreted as normalising the monetary policy parameters to adjust them to the conditions that existed before the COVID-19 pandemic.

In the press release following the meeting, the Council has once again pointed to the supply-side factors (the rise in prices of commodities and CO2 emission allowances, pandemic-related supply disruptions and earlier increases in electricity and natural gas prices) as the main reason behind the inflation rise in 2021. Like in the previous months, the Council has once again referred to the additional factor boosting inflation, namely the continuing economic recovery, including rising household income. In the Council’s opinion, inflation, boosted by a rise in regulated tariffs on electricity, natural gas and heating will remain at an elevated level also in 2022, but the so-called Anti-inflation Shield will have a curbing impact on it. In a longer perspective, the Council expects the inflation to decrease, which will be supported by expected fading of some of global shocks currently boosting price growth as well as by the increase in the interest rates carried out by the NBP so far.

MPC prefers stronger PLN to higher interest rate hikes

Today’s decision of the Monetary Policy Council is consistent with the NBP President’s statements made over the last couple of weeks, which were indicative of the intention to continue the tightening of the monetary policy, the main aim of which being to strengthen the PLN. This was officially referred to in the press release, which contains a new passage, reading: “Zloty appreciation would be consistent with the direction of the monetary policy conducted by the NBP.” The press release still contains the passage which reads that the “NBP may still intervene in the foreign exchange market (…) and the timing and scale of measures taken by the NBP will depend on the market conditions.”

The addition of that passage to the press release is understood given the results of research on the mechanism of transmission in the monetary policy. Under normal circumstances, the maximum response of core inflation is, in around one-third, driven by the effects of the interest rate and credit channels, and, in two-thirds, by the effects of the exchange rate channel (see MACROmap of 15/11/2021). However, the exchange rate channel of transmission of interest rates to inflation is currently obstructed, as the PLN is not markedly appreciating despite the tightening of the monetary policy.

It should be also noted that the PLN weakened significantly right after today’s decision of the MPC was announced (EURPLN rose by over 0.01). This means that investors expected that today’s interest rate hike would be stronger. If the MPC wants the PLN to appreciate, it would have to tighten the monetary policy faster or make the investors expect a larger scale of total rate hikes. Otherwise, the exchange rate channel of the monetary policy transmission will remain obstructed, curbing the anti-inflationary impact of interest rate hikes. In our opinion, the probability of a direct intervention in the foreign currency market is currently low.

Monetary policy tightening cycle to continue

The Council keeps on declaring that its “decisions in the coming months will continue to be aimed at reducing inflation to a level consistent with the NBP inflation target in the medium term, while taking into account economic conditions, so as to ensure medium-term price stability and at the same time support sustainable economic growth after the global pandemic shock.” Like it was in January, the Council made the monetary policy tightening scale contingent on the “incoming information on perspectives for inflation and economic growth, including situation in the labour market.”

The press release following the MPC meeting supports our scenario in which the Council will continue to tighten the monetary policy in the months to come. We believe that interest rates in Q2 2022 will stand at 4.25%. However, the scenario in which the Council will decide to speed up tightening the monetary policy by increasing the interest rates by 75bp in March cannot be ruled out. The way the EURPLN will run in the weeks to come, the publication of the inflation data for January and the results of the March inflation projection will come as important factors that will influence this decision. Tomorrow’s press conference of the NBP President will shed more light on the monetary policy perspectives.

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