Interest rate increases will not be enough to lower inflation in Poland, and actions through the exchange rate channel are also needed, assess Citi Handlowy economists. In their opinion, the implementation of the inflation target would be helped by the MPC’s communication cutting off the weakness of the zloty, as well as the sale of currencies on the market by the Ministry of Finance and – on a smaller scale – by the National Bank of Poland.
“The goal of lowering inflation can be achieved in a number of ways. Nevertheless, the fastest and most effective way to do this is to rely not only on interest rate increases, but also on the strengthening of the zloty. That is why the communication of the MPC, cutting off from the weakness of the zloty and at the same time clearly supporting a stronger exchange rate, could help achieve the inflation target, “the report reads.
“Moreover, in our opinion, the power of communication could be strengthened if the words were followed by actions in the form of selling currencies on the market – by the Ministry of Finance and (on a smaller scale) by the NBP. Such steps may seem far-reaching, but are not controversial from an economic point of view. In the past, the NBP and the Ministry of Finance were more active in the currency market, and the current perspective of very high inflation (much above the main target of the MPC) seems to justify a return to similar activities “- added.
Citi economists emphasize that official statements and statements of the MPC representatives show that the current policy of the Council was more or less to raise interest rates, but not to strengthen the zloty at the same time. In their opinion, however, such a strategy means that lowering inflation will be more difficult, longer-lasting and may require much larger rate hikes than would otherwise be necessary.
“An interest rate hike by one percentage point may subtract half a percentage point from inflation, but on the condition that the zloty appreciates in reaction to the rate hikes. According to these NBP research, in the first quarters, immediately after the rate hike, the vast majority (at least 3/4) of the inflation lowering effect comes from the stronger currency, and not from the rate hike itself and its impact on other spheres of the economy “- it was written.
“By raising interest rates, but at the same time trying not to strengthen the zloty, the MPC has less chance of success. In order to achieve the same anti-inflationary effect in a relatively short time without the support of the exchange rate channel, the MPC would have to raise interest rates not by 1.25 points, but by by an additional 4 percentage points to over 5%. We emphasize that these are rough estimates, but they reflect the problem facing the Polish economy. Such a strategy could end very painfully for companies and households that are particularly indebted, and ultimately also for the stability of the sector Therefore, getting rid of the exchange rate mechanism seems unjustified “- added.
According to the authors of the report, in the case of nominal interest rates in Poland, the minimum plan for the coming months is to raise them to slightly above 2.5 percent.., which would allow achieving slightly positive real interest rates.
In the opinion of economists, it is also necessary to take actions aimed at strengthening the domestic currency – the MPC’s departure from signaling fears of zloty appreciation towards signaling preferences for a strong currency.
“However, it can be assumed that a significant change in the way of communication on the part of the MPC would increase the chances for a strengthening of the zloty. In recent weeks, many investors with whom we talked were convinced that despite interest rate hikes, the MPC wanted to avoid the strengthening of the zloty. Memory of intervention in December 2020. additionally, it limited the appetite for the purchase of the Polish currency before the end of the year. To change this, a 180-degree turn in the communication of the MPC would be necessary – a departure from signaling fears of zloty appreciation towards signaling preferences for a strong currency “- it was written in the report.
The inflation problem is so serious that the shift in communication would be perceived as fully justified, and at the same time it would leave no doubts that the MPC’s goal is to lower inflation. On the other hand, any softening of this statement could create the impression that low and stable inflation is not the only goal, “he added.
According to Citi economists, the Monetary Policy Council’s preference for a stronger currency could be strengthened and authenticated if the declarations were followed by deeds.
“For example, the NBP could declare its readiness to sell the currencies it bought in December last year as part of the intervention. This would allow the NBP to siphon off some of the excess liquidity from the market, and at the same time signal a return to the situation from before December 2020. intervention and could be spread over several weeks, as, for example, the Czech central bank is planning a systematic (spread over time) sale of income from reserves. In this case, the direction of activities and their signaling effect would be more important than the scale of currency sales “- it was written.
“Secondly, the Ministry of Finance could return to its old practice of currency conversion on the market. Over the years, funds from the EU were exchanged for zlotys directly on the market, which supported the zloty in the period of excessive depreciation. After 2016, the scale of these operations has decreased and now practically it does not matter much. If the Ministry of Finance decided to return to this practice, several billion euros could reach the market annually. The chances of such a solution slightly increased in the light of the recent statements of Prime Minister Morawiecki, who signaled the readiness to act towards strengthening the PLN. of such steps would also reduce the pace at which the excess liquidity resulting from the exchange of currencies at the central bank is growing, “he added. (PAP Biznes)
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