Interest rates remain unchanged. The impact of supply shocks on inflation is easing

Today, the Monetary Policy Council has taken a decision to keep interest rates unchanged (with the NBP reference rate standing at 6.75%). The Council’s decision was consistent with market consensus and our forecast. In the press release following the meeting, the Council pointed to the inflation drop in June, and in particular to the core inflation, which is expected to fall once again. The passage concerning the impact of supply shocks on inflation was significantly modified. The part that referred to the “significant increase in costs resulting from an earlier strong surge in global commodity prices and disruptions in global value chains” being “passed through to consumer prices” has been removed from the text. At the same time, the press release still contains the opinion saying that the PPI inflation continuing to fall “signals a further easing of external supply shocks”. The changes suggest the Council believes that the impact of supply shocks on inflation invoked by the pandemic and the war in Ukraine is easing.

The Council still expects inflation to return to its target gradually

Like in June, also this time the Council concluded that “given strength and persistence of the recent shocks that remain beyond the impact of domestic monetary policy, inflation’s return to the NBP inflation target will be gradual.” The Council has concluded that inflation will be driven down by the weakening of the external economic conditions, a decline in commodity prices, and a weaker GDP growth (including consumption) amid a significant decrease in credit growth. The Council has once again declared that its “further decisions (…) will depend on incoming information regarding perspectives for inflation and economic activity.”

NBP projection results still an argument in favour of monetary policy tightening

According to the July projection of the NBP prepared on the assumption of unchanged NBP interest rates and using the data available as of 22 June 2023, there is a 50-percent probability that inflation will be in the range of 11.1-12.7% in 2023 (vs. 10.2–13.5% in the previous projection), 3.7-6.8% in 2024 (vs. 3.9-7.5%) and 2.1-5.1% in 2025 (2.0-5.0%). The near-term inflation path projection was thus slightly revised downwards vs. the projection presented in March. Furthermore, the projection results show that in 2024-2025 inflation will run markedly above the MPC inflation target of 2.5%, which in our opinion is an argument favouring the tightening of the monetary policy. Lack of the MPC’s reaction to inflation target overshooting expected in the projection supports our conclusion in which the Council still finds the mid-term inflation outlook to be of secondary importance, and that preventing the economic growth from slowing down too much in the coming quarters is still the main objective of the monetary policy. In accordance with the projection, there is a 50-percent probability that GDP growth will be in the range of -0.2-1.3% in 2023 (vs. -0.1-1.8% in the previous projection), 1.4-3.3% in 2024 (vs. 1.1-3.1%), and 2.1-4.4% in 2025 (vs. 2.0-4.3%). Therefore, the scenario as seen in this projection is that of a slightly lower economic growth (comparing to the March projection) that will reach the value of around 0.5% in 2023, and then gradually accelerate in the subsequent years.

MPC reaction function blurred. Interest rate cuts will take place in Q4 2023

In our revised scenario, inflation falling faster in the months to come than we previously expected will cause the Council to cut interest rates in its meetings in October and November (by 50bps in total). This scenario is consistent with the condition for rate cuts named by the NBP Governor at the press conference following the MPC meeting in June, i.e. inflation reaching a single-digit level amidst the certainty of its falling in subsequent quarters. We believe the condition mentioned above will be met in October, which will enable the MPC to cut the rates before the parliamentary elections.

The rate cuts prerequisite as formulated by the MPC Governor confirms that inflation returning to the MPC target (2.5%) in the medium-term perspective is not the MPC’s priority at the moment. The prerequisite makes it possible to support the economic policy of the government through interest rate cuts even amidst high inflation that is very far from returning to the inflation target, the return being delayed by the economic upturn that is expected to take place in 2024. In our opinion, this means that the function of the central bank’s reaction has changed in such a way that the monetary policy is becoming less transparent and comprehensive, and consequently, less predictable. In the next MACROmap, we will discuss in detail our revised inflation and interest rates forecast.

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

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