Economic Analysis - Hawks To Gain Traction In 2018 - APR 2018

BMI View: The National Bank of Poland ' s dovish stance will prove increasingly u ntenable over the course of 2018 amidst rising domestic price pressures and a global reflationary environment. We forecast the National Bank of Poland to hike rates once by the end of the year, which is not yet fully priced by rate markets.

We have revised down our end-2018 policy rate forecast for Poland from 2.00% to 1.75%, implying just one 25 basis point (bps) hike by the end of the year. The downward revision reflects several factors including the ongoing dovish stance of the National Bank of Poland (NBP)'s monetary policy committee (MPC), and the sluggish rebound in core inflation over 2017. That said, we continue to see inflation risks as tilted firmly to the upside and forecast headline consumer price index (CPI) growth to approach the upper end of the NBP's tolerance band (2.5% +/- 1pp) by Q418 ( see chart below). Our expectation for tightening is in line with a theme of global reflation playing out in the early part of 2018, which is reflected in rising developed state yields and a growing number of central banks commencing a tightening path. Our end-2019 policy rate forecast for Poland is unchanged at 2.50%.

Inflation Comfortably In Range For Now
Poland - Consumer Price Index, % chg y-o-y
Source: National Bank of Poland, BMI

The Dovish Case: Few Signs Of Underlying Price Pressures

NBP President Adam Glapinski foresees the policy rate staying on hold at 1.50% well into 2019, and comments from other MPC members suggest the bank would even tolerate a temporary overshoot of the upper end of the inflation tolerance band. Furthermore, the balance of power on the National Bank of Poland's MPC tilted more firmly in favour of the dovish camp in Q417.

The MPC's stance appears broadly justified based on current trends in underlying prices. The surge in headline CPI to a peak of 2.5% y-o-y in November 2017 was primarily due to supply side factors, and began to wear off by December when inflation declined to 2.1%. Meanwhile, after peaking at 1.0% y-o-y in September 2017, core inflation (excluding food and energy) eased to average just 0.9% in Q417.

Appreciation of the Polish zloty is furthermore adding a deflationary impulse to the economy, which will help to offset the need for a tighter monetary policy. The currency has appreciated by 5% against the euro and by 8% in trade-weighted terms over the past year, and we expect further modest appreciation over the coming quarters.

Limited Inflationary Impulse From Eurozone
Poland CPI Excluding Energy And Food & Eurozone Core HICP, % chg y-o-y
Source: NBP, Eurostat, BMI

Meanwhile, risks of a sudden spike in imported inflation emanating from Poland's main eurozone trading partners appear well contained. The European Central Bank (ECB) is firmly on a tightening path and the eurozone's economic expansion will be relatively robust in 2018, but both headline and core eurozone inflation remain subdued and well anchored below the bank's target of just under 2.0%.

The Hawkish Case: The Perfect Storm For Inflation

Macroeconomic conditions are increasingly aligned for a rise in inflation. Against a backdrop of very strong consumption-led GDP growth, the labour market is historically tight. Labour shortages and record-low unemployment will drive a steady acceleration of wage growth, which is already running at an eight-year high. Industrial capacity utilisation in Q417 was just 0.4pp below the pre-global financial crisis peak of 81.1%, yet investment in machinery and equipment has been subdued ( see ' Weak Investment And Politics Cloud Otherwise Strong Outlook ' , January 11). In conjunction with labour shortages, this implies that production constraints and demand-pull price pressures may build in 2018.

Current Period A Historical Anomaly
Poland - Unemployment, Wages & Policy Rate
Source: Central Statistics Office, NBP, BMI

Facing a broadly similar macroeconomic backdrops, the central banks of the Czech Republic and Romania have already begun hiking rates in response to rising core price pressures. We see this as a sign that the traditional relationships between macroeconomic factors (i.e. labour market, wages) and inflation are broadly intact in the region, and see few reasons to believe Poland will be the exception.

Survey data suggests that inflation and selling price expectations are beginning to rise within the business sector. The NBP's Q317 inflation expectations survey shows the highest proportion of firms since Q111 expecting inflation to accelerate over the next 12-month. The European Commission's December 2017 business surveys show rising selling price expectations over the next three months across all sectors, most prominently in construction. While expectations in the services sector remain subdued, we note that the balance statistic in all three main sectors was positive for each month of Q417, the first time this has occurred since 2011.

Inflation Expectations Rising
Poland - NBP Inflation Expectations Survey (LHS) & Eurostat Business Survey, Selling Price Expectations Over Next 3 Months, pp balance
Source: NBP, Eurostat, BMI

Global inflation risks are tilted firmly to the upside amidst strengthening global growth and the recent rise in oil prices ( see ' Global - Growth, Inflation And Rates On The Rise ' , January 19 ). The latter factor in particular implies that the NBP is perhaps overly sanguine in its assessment that supply side effects will wear off in H118, and may be underestimating second-round effects on core prices. Meanwhile, market-implied inflation expectations, and in turn interest rate expectations, are fairly uniformly rising across developed states.

We are above consensus with regards to the pace of rate hikes in the US and Canada, and have turned more hawkish in recent weeks with regards to our expectations for the ECB ( see ' Week Ahead - Balancing Act For ECB ' , January 19). As the trend of monetary tightening becomes more firmly entrenched across both developed and emerging markets, we expect this to make Poland's MPC more willing to also adopt a more hawkish stance as 2018 progresses.

What Are Markets Saying?

Despite the aforementioned global trends, market-implied rate expectations for Poland have edged down over recent weeks. That said, forward rate agreements (FRA) continue to price in modest tightening over the coming 12 months, and thus show a more hawkish bias relative to the dovish commentary and forward guidance from the NBP. We see scope for rate expectations to rise over the coming quarters, in line with our forecast for a 25bps hike by end-2018. At the time of writing, the FRA market prices the 3-month WIBOR interbank benchmark rate at just 23 basis points higher in 12 months' time.

Tightening Bias In Rate Markets
Poland - 3m WIBOR & Forward Rate Agreements, %
Source: Bloomberg, BMI