Doves with hawkish faces

More than six months ago the expectation was that the new Monetary Policy Council would cut its benchmark interest rate by March — it hasn’t happened yet.
NBP do RPP kwadrat

Headquarters of NBP, Warsaw, Poland (Narodowy Bank Polski, CC BY-ND)

Headquarters of NBP, Warsaw, Poland (Narodowy Bank Polski, CC BY-ND)

A more thorough look at the condition of the economy and statements from members of the MPC, have forced the market to verify these assumptions. People are now talking about rates being left unchanged throughout 2016 and the first increases coming at the end of 2017.

“We have deflation. Economic growth is still low. Therefore, there is no use in squeezing these interest rates now. The inflation target hasn’t been met. Clearly there should be a decrease,” this statement made by Henryk Kowalczyk for PAP on October 21st, 2015 launched speculations on the dovish composition of the new MPC. Especially as Kowalczyk , the current head of the Standing Committee of the Council of Ministers (at that time Law and Justice (PiS) MP responsible for the party’s economic programme) confirmed that views on rate cuts will be important in the selection of candidates for the MPC.

The Council has 10 members. It is chaired by the President of the Polish central bank Narodowy Bank Polski (NBP), who until June 2016 is Professor Marek Belka. The remaining nine members are appointed in equal numbers by the President, the Sejm (the lower house of the Parliament) and the Senate (the upper house of the Parliament). In the case of the Council’s fourth term, there are eight new members, because the term of Professor Jerzy Osiatyński, who replaced Professor Zyta Gilowska on December 20th, 2013, will end on December 2019. As a result, Sejm appointed three members, the Senate appointed the same number, but the President only appointed two.

Formation of the Council and development of a view

The Senate was the first to make its selection. On January 13th it appointed Dr. Marek Chrzanowski, Professor Eugeniusz Gatnar and Dr. Jerzy Kropiwnicki  (they took the oath of office on January 25th). On January 30th the Sejm appointed Dr. Grażyna Ancyparowicz and Dr. Eryk Łon. On February 17th the President appointed Dr. Łukasz Hardt and Dr. Kamil Zubelewicz. On March 18th the Sejm appointed Professor Jerzy Żyżyński.

A two-day meeting held on March 10-11th was attended by seven new members, as well as Belka and Osiatyński. This was the first opportunity for a possible rate cut, but it did not happen. This wasn’t a surprise considering the statements made by the members of the MPC during the hearings in the Senate and the Sejm committees and in the media.

“We have no reason to change the monetary policy which is currently being implemented. And we may change this position in half a year, when the basic programmes enter into force, and then we may reconsider this issue,” Ancyparowicz said on January 12th at a Sejm committee hearing.

“Monetary policy is quite effective when it comes to halting economic growth. However, its effectiveness in stimulating the economy isn’t as certain. There is one primary reason for that: the expectations concerning future growth and the profitability of the undertaken activities by the potential borrowers,” explained Kropiwnicki in the Senate on the same day.

“This level of interest rates is simply good for Poland,” added Gatnar on January 13th.

“There is a risk that an interest rate cut would not result in the CPI moving significantly closer to the inflation target,” argued Chrzanowski in an interview with PAP on January 15th.

“There is no reason for the MPC to lower interest rates,” Hardt told Bloomberg on February 23rd.

“The previous Monetary Policy Council correctly identified the causes of deflation and rightly decided not to combat it at any price,” Zubelewicz told PAP on March 3rd.

Only two members voiced dovish opinions: Łon and Żyżyński.

The former said during a meeting of the Sejm committee on January 12th that, “We should consider central bank intervention if it is difficult to get out of deflation,” Żyżyński said in an interview with PAP on February 16 that he would “in general, be for a reduction of interest rates”, but in the same sentence mentioned arguments against such course of action – the most important of which would be a fall in profits of the cooperative banking sector.

There were also no surprises in the opinions of members appointed for the MPC’s third term: Belka and Osiatyński.

“In these times, it is better to wait and not to expose the Polish economy to any additional risks,” said the NBP President on February 3rd on a potential reduction of rates. On January 22nd in an interview with Bloomberg, Osiatyński even assessed that, “we are in the mode of waiting for changes, with a view to tightening monetary policy rather than easing it.”

Therefore, out of 10 members of the Council, eight are against rate reductions, and two would consider  them only under certain conditions.

Deflation will last longer

This balance of forces could be changed by inflation and GDP projections prepared by the NBP Economic Institute, which constitute an important indication for each Council. There are three updates issued every year: in March, July and November. The March projection coincided with the meeting of the MPC in its new composition, but the projection contents were not unequivocally dovish. Admittedly, the inflation path was significantly lowered compared with the previous projection, but the GDP path was revised upwards.

The NBP Economic Institute assumes that the annual growth of prices in 2016 will be in the negative range of -0.9 to -0.2 per cent (that would mean an entire year with deflation, while as late as November inflation of 0.4 to 1.8 per cent was assumed). Full-year deflation would end in 2017 with price growth figures in the range of 0.2 to 2.3 per cent (previously the range of 0.4-2.5 per cent was assumed), and in 2018, we would finally have a chance of getting close to the 2.5 per cent inflation target, as the expected range is 0.4-2.8 per cent (compared with 0.4-2.5 per cent in the previous projection).

This would probably be sufficient for rate cuts, if not for the projected GDP growth rate. The projected range is 3-4.5 per cent for this year (previously 2.3-4.3 per cent was expected), 2.6-4.8 per cent in the next year (an increase from 2.4-4.6 per cent) and 2.1-4.4 per cent in 2018.

“If the nearest projection of inflation and the monetary easing on the part of the ECB does not prompt our Council to cut rates, then the probability of such a move in the coming few months will gradually decline, because the economy will accelerate and inflation will slowly but steadily rebound,” according to an analysis by Bank Pekao on  March 4th, just ahead the meetings of the ECB and the MPC.

The economists at Morgan Stanley took the opposite view: “We previously thought that the new MPC could cut interest rates as early as March, but now we feel that the MPC will delay the decision until the second quarter,” they wrote on February 26th.

Long-term outlook

The change in attitude from dovish to neutral can be seen in the PAP consensus. As many as 15 of the 22 economists surveyed by the agency in March believed the MPC would not change rates this year. As late as the beginning of January 14th of the 22 economists saw a reduction by 25 to 50 basis points in the first half of the year as the likeliest scenario.

In the March survey, only the analysts at BZ WBK expected an immediate rate cut.

“Our expectations regarding rate cuts still boil down mainly to a lower inflation path in the March projection. Quantitative easing on the part of the ECB and the strengthening of the zloty are also of significance. This gives the Council some room for monetary easing. Maybe it will be later than in March, maybe it will not be a reduction in the reference rate but, for example, a reduction of the required reserve ratio. Such a solution would be positive for the banking sector and would neutralize the concerns about the cooperative banking sector,” said Marcin Luziński from the Economic Analysis Department at BZ WBK in an interview with the CE Financial Observer.

Credit Agricole expects a cut of as much as 50 basis points in July at the next inflation projection. According to the bank’s economists, the high GDP path in the March projection was derived from positive data at the end of 2015. In the fourth quarter of 2015, Poland’s GDP was 3.9 per cent higher than for the same period a year earlier. In the first quarter of this year, however, they expect a slowdown that will come out in the July projection and will persuade the MPC to cut rates.

For the time being, however, arguments against a cut are dominating both among economists and – more importantly – among Council members.

“An assumption of GDP growth in 2016 at the level of 4 per cent is not particularly heroic,” Kropiwnicki said on March 11th at a conference after the MPC meeting.

It is difficult to find lower forecasts because growing budgetary expenditures will ensure a boost to economic growth in the near future. The new program “Rodzina 500 plus,” handing out PLN500 per month to families for second and additional children, alone will account for new spending of over PLN17.5bn in its first incomplete year of operation, which will translate into an increase in consumption.

“This PLN17.5bn should translate into additional GDP growth of about 1 per cent, which according to NBP’s NECMOD model, is synonymous with a reduction in interest rates by about 250 to 300 basis points. And further legislation is on the way. For example, the increase of the tax-free personal allowance, ordered by the Constitutional Court, would amount to about PLN7bn, or an additional 0.4 per cent of GDP, which corresponds to interest rate reductions by an additional 100-130 basis points,” said Michał Rot, an economist at PKO BP.

The effects of rate cuts are visible between 12 and 18 months after introduction. Therefore a reduction carried out now means the impact will kick in just as the economy comes out of deflation on its own, creating the risk of excessive inflation. As part of the so-called policy mix, loose budgetary policy should be accompanied by a more restrictive monetary policy.

“The 500+ programme, the increase of the tax-free personal allowance and the lowering of the retirement age may have a considerable impact on macroeconomic indicators such as domestic demand, through the action of the consumption multiplier,” Chrzanowski said on an interview with PAP on January 15th.

A steep rate cut is therefore unlikely, much like changes in NBP towards a Polish TLTRO  (Targeted longer-term refinancing operations), that is, a programme in which the central bank generates money it then lends out to commercial banks at a low margin in order for them to lend to companies. The idea was present in the election programme of PiS, but was not included in the “Morawiecki plan,” promoted by Deputy Prime Minister Mateusz Morawiecki. The new MPC also seems sceptical about this idea.

“I don’t see such a need now. Companies have good access to credit. The credit gap is estimated at 10 per cent and this only applies to small and micro-sized enterprises. This gap is mainly associated with a certain asymmetry of information, and lack of economic knowledge,” explained Gatnar at a Senate committee hearing when asked whether he saw a need for NBP to launch non-standard instruments to support the economy.

Besides, additional stimulation of the economy by the central bank would require changes in that institution, and would probably be an excessive and unnecessary risk after the ratings downgrade by Standard & Poor’s, the rating agency, and ahead of looming reviews by other agencies.

There are many indications that the MPC will only use conventional tools and that the first change concerning interest rates will not be a decrease, but an increase – in the next year.

This is how some analysts are already looking at the situation.

“We don’t assume rate reductions in 2016, because experience shows that each Council feels the most comfortable neither reducing nor increasing interest rates. At the end of next year inflation should almost certainly exceed 1.5 per cent, however. With a reference rate at the same level, this means that the real rate would reach zero. A cycle of cautious increases should therefore begin at the end of the next year,” said Aleksandra Świątkowska of BOŚ Bank.

Other economists are adding that possible further rating downgrades, budgetary problems and an outflow of capital could force the Council to defend the value of the zloty even before that.

However, if there are no worrying events in the global economy, then the new Council could enjoy a calm beginning of its term, as opposed to the first Council (1998-2004), which set an inflation target and floated the zloty exchange rate, the second one (2004-2010), which battled the huge crisis in the global economy after the collapse of Lehman Brothers, and the third one (2010-2016), which had to deal with the consequences of this crisis and the increasingly unconventional policy of the main central banks.

In the case of the second Council, similarly optimistic assumptions unfortunately had to be quickly revised. The situation in the years 2016-2022 may indeed be calmer; however, even if this is not the case, then the MPC still has the tools necessary to respond. A positive reference rate at the level of 1.5 per cent provides a certain comfort, much like a sovereign national currency and the fiscal stimulus being carried out by the government.

The most likely scenario for the coming years, therefore, is a lack of change at first, followed by a gradual increase in rates starting from the end of 2017, along with the rhythm of the business cycle. We should not, however, expect an entry into the euro area and the surrender of an independent monetary policy.


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