IHS Global Insight Perspective | |
Significance | The rate cut by 75 basis points is the second such reduction in a row. Supporting growth figures as the top priority on the Council’s agenda. |
Implications | Easing monetary-policy terms seems warranted given current economic conditions. However, risks for zloty depreciation are high, making Poland’s current euro-adoption target date of 2012 all but unattainable. |
Outlook | More rate cuts are to follow. Cuts of 50 or even 75 basis points are possible in February and March, depending on the outcome of GDP, production, and sales data for the first quarter. |
Poland’s Monetary Policy Council resolved to cut the key policy rate by 75 basis points (down to 4.25%) at the regular monthly meeting yesterday, raising the total score of rate cuts to 175 basis points since the easing cycle started in November. The scope of the latest reduction was a bit more than expected, as most forecasters had predicted a less aggressive move of 50 basis points. However, the step clearly reflects the Council’s concern over Poland’s economic growth momentum; this has been suffering severely as a result of the recession in Poland’s major export markets, which include Germany and other Western European countries, Russia, and Ukraine, as well as Poland's Central European neighbours.
Inflation and the fairly downbeat zloty have been all but eclipsed from the Council’s radar screen at the moment. At least as far as inflation is concerned, the Council surely has a point, as inflation will hit the Council’s medium-term target rate of 2.5% quite soon, in February or March at the latest, and will then slow down further afterwards. The zloty, which had been depreciating further last week (see Poland: 26 January 2009: Polish Zloty Hits Five-Year Low Against Euro) in anticipation of falling interest rates, will surely grease inflation from the import side, but in the absence of global demand-side pressures, and with falling commodity prices worldwide this is hardly of major significance at the moment.
There is no question that growth momentum in Poland is faltering. Industry has reported sagging output in both November and December, and although GDP will still expand in the first half of the year, growth rates could get rather close to stagnation. Meanwhile, room for fiscal stimuli is limited by the fact that Poland’s public-sector deficit has come fairly close to the Maastricht ceiling in 2008, and is likely to surpass it in 2009 unless the government enacts harsh spending cuts, which of course would only aggravate the situation. The onus is thus on monetary policy to stimulate demand by striving for lower refinancing costs for companies.
The strategy would work perfectly if Poland’s financial markets were isolated from the rest of world. Unfortunately, as Poland is now highly integrated, there are serious stability risks attached to a rather aggressive policy approach, because cutting interest rates too far could further undermine the zloty. Poland’s sizeable public foreign debt and foreign-currency-denominated private sector debt—including many households that have taken out mortgages in Swiss francs and euro—will soar further in zloty terms if the Polish currency maintains its downward trend. It is true that Poland is only following steps already taken by the U.S. Federal Reserve, the European Central Bank, and also other central banks in the region, but the zloty could soon come under much stronger pressure if doubts about private or public sector foreign debt emerge. An emergency rate increase would be unavoidable in this case. However, although the zloty’s depreciation has been quite steep since its high in July 2008, it is still manageable from the point of view of foreign debt, and it is also welcome from an exporter’s point of view. As all other currencies in the Central European region have suffered similar declines, the depreciation of the Polish zloty could even be regarded as necessary to ensure Polish price competitiveness in relation to other central European countries.
Outlook and Implications
More rate cuts are to follow, with another one by 50 or even 75 basis points being possible, depending on the outcome of GDP, production, and sales data for the first quarter. In the words of council member Dariusz Filar, usually regarded as one of the hawks, the council will pursue "deeper cuts over a shorter period", which means that the policy rate could come down to 3.75% in February, and 3.25% in March. By year-end, the policy rate will level at 3.00% in IHS Global Insight's baseline, which still seems tolerable given that a significant rate spread to the euro and the U.S. dollar interest-rate levels will be maintained.
Deeper rate cuts could possibly seriously undermine the zloty. Overshooting effects played a role a year ago when the zloty surged to decade-highs against the U.S. dollar and the euro, but they might now play a role on the downside as well. Unfortunately, this does not protect the zloty from further depreciation in the short term, which we deem likely. However, with the situation on the global scale and in Poland stabilising in the second half of the year, we believe that it could start to recover in the second half of the year. Poland’s current euro adoption schedule is surely at risk in this scenario; joining the European Exchange Rate Mechanism in the first half 2009, which would be necessary in order to join the Eurozone in January 2012, is hardly a feasible option as long as the zloty remains under stress.