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Monetary policy outlook for 2013 in light of inflation trends


2013-02-04

In 2012 the Polish economy entered a disinflationary trend that we expect will continue also in 2013. With CPI inflation running below the central bank’s target rate, the Monetary Policy Council will have comfortable leeway to reduce interest rates in the months ahead. However, it appears that the current rate-cutting cycle has passed its mid-point and that we are closer to the pause in monetary easing hinted at by NBP governor Marek Belka. How long that pause lasts will depend on macroeconomic data for the first months of 2013.

Inflation on a downward course…

The second half of last year brought a significant fall in inflation. In December 2012 the CPI dropped below the NBP target rate for the first time since August 2010. Price growth decelerated across all categories of consumer goods and services, due to a high comparative base from a year earlier.

The National Bank of Poland (NBP) Act of 1997 stipulates that “the primary objective of the NBP is to maintain price stability, while at the same time supporting the economic policy of the government, insofar as it does not detract from the central task”. This means that in deciding about the level of interest rates in Poland, the Monetary Policy Council (RPP) takes into consideration the projected inflation rate in a given time horizon (usually three years), while paying close attention to developments in the real economy, both at home and abroad. The central bank produces its own inflation and GDP growth forecasts three times a year: in March, in July and in November. Although the publication date of the first of this year’s projections is still some time away (its first details will be unveiled in the press release following the RPP’s March session early next month), latest macroeconomic figures clearly indicate the absence of inflationary pressures in the economy and a strong disinflationary trend.

After an extended period of stubbornly high inflation (between January 2011 and June 2012 the consumer price index in Poland hovered at an average of 4.2% y-o-y, i.e. significantly above the upper end of the NBP’s target band of 2.5% +/- 1 p.p.), in May 2012 the RPP decided to lift interest rates by 25 basis points. However, in the second half of last year inflation slowed down markedly, and in December 2012 stood at 2.4% y-o-y, coming in below the target rate of 2.5% y-o-y for the first time since August 2010. All categories of goods and services contributed to the decline in CPI inflation in 2012, including food and non-alcoholic beverages, where price growth came down to an average of 4.3% y-o-y from 5.4% y-o-y a year earlier, and fuels, where inflation eased to 11.1% y-o-y from 13.6% y-o-y in 2011.

Consumer prices can be expected to fall further, and the disinflationary trend to continue, in the new year. In January the CPI is likely to have come down to 2% y-o-y, due to lower gas prices (the price of natural gas for households was reduced by about 10% and for the biggest industrial users by just over 3%) and a possible decline in energy prices, which outweighed increases in waste disposal charges and in the prices of newspapers. And prices will ease even more in the subsequent months, with the CPI likely to slide below the lower end of the central bank’s target band (i.e., 1.5% y-o-y) in June, owing in large part to a high comparative base from 2012.

… supported by labour market weakness and PPI deflation

The disinflationary trend will continue this year, with both demand- and supply-side factors working in favour of low inflation, from weak consumption to a stabilisation in commodity prices to reductions in natural gas prices. We expect inflation to remain below the NBP’s target rate throughout the whole 2013.

The situation on the labour market will be one of the factors contributing to low consumer inflation in 2013. With the economy in slowdown mode and with companies reluctant to add jobs, there will be little in the way of upward wage pressure, an assumption supported by latest surveys of business conditions. According to Szybki Monitoring NBP, a poll of companies conducted by the central bank in December 2012, “the percentage of companies planning to cut jobs still outnumbers those planning to increase employment (14.7% to 9.8%). The sector with the highest share of firms planning job reductions is the construction industry. […] The proportion of companies saying they will increase wages in the next three months declined for another consecutive quarter in Q4, with only 17% of the surveyed firms planning pay rises in Q1 2013, which is the lowest level since 2009. […] It is worth noting that despite the mounting problems, companies are still relatively slow to reduce wages, with just 4.3% of those surveyed planning to do so in Q1 2013, though in the construction industry the figure is much higher at 11.9%”. Taking into consideration the findings of the NBP survey, we can expect that the rate of wage growth in the enterprise sector might be slightly higher than inflation, at about 2-3% y-o-y on average. Nonetheless, there is no risk of so-called second-round effects emerging this year as the labour market outlook remains weak. On the other hand, this gradual expansion of the real wage bill should help stabilise private consumption, and under a more optimistic scenario (assuming a rebound in eurozone growth and increased external demand for Polish goods) it might even contribute to a recovery in consumer spending in Poland, supporting economic growth in the second half of 2013.

Another factor that will work in favour of lower CPI inflation is the deceleration in producer price growth. The producer price index (PPI) slowed sharply in recent months, dropping from a local high of 9.1% y-o-y in November 2011 to -1.1% y-o-y in December 2012. This is a reflection of weak inflationary pressures in the production sector, due to a combination of, on the one hand, sluggish demand for manufactured goods and a strong deceleration of industrial output, and, on the other hand, a stabilisation of commodity prices on world markets and slow growth of wage costs. This means producers will feel no pressure to pass on rising costs to consumers. I expect the PPI to hover around zero throughout 2013.

Rate-cutting cycle under way …

In November 2012 the RPP embarked on a monetary easing cycle with a 25 basis point reduction in interest rates. The Council opted for a gradual pace of monetary loosening because most of its members believe the economic slowdown is temporary.

In November 2012 the Monetary Policy Council started a cycle of monetary easing with a cut in interest rates of 25 basis points. Another quarter-point reduction came in December, bringing the reference rate down to 4.25% at the end of 2012. The Council decided to act only after it became clear that the scale of the economic slowdown was significant (a view later confirmed by official data showing that in Q3 growth had plummeted to 1.4% y-o-y from 4.6% y-o-y in Q4 2011), and in the absence of upward risks to inflation in the medium term.

It is worth noting that in 2012 there were quite substantial differences of opinion among the RPP members as regards the economic outlook and inflation trends. Last year also witnessed some interesting shifts in the balance of doves and hawks at the Council. Andrzej Bratkowski, one of the staunchest advocates of interest rate increases during the two preceding years, became a major proponent of monetary easing last year, presumably seeing the threat of slowdown in the economy and the consequent reduction of the risk that inflationary pressures will become entrenched. Mr. Bratkowski was one of just two RPP members - alongside the traditionally doveish Elzbieta Chojna-Duch − who did not support the controversial rate increase in May 2012, and since July both he and Mrs. Chojna-Duch have voted consistently in favour of rate cuts. However, Mr. Bratkowski’s motions for rate reductions of well over 100 basis points failed to muster any meaningful support within the Council. Examining the results of internal RPP votes, it is noteworthy that it was not until October 2012 that NBP governor Marek Belka (and RPP member Anna Zielinska-Glebocka) saw the need to reverse the May increase. And even then the hawkish camp was strong enough to delay a rate cut until November. This suggests that the views of the NBP governor may not be central to the RPP’s decisions in the months ahead.

Assessing the RPP’s policy stance in 2012, it must be said that the Council left it too late to cut interest rates. Its policy was excessively backward-looking, too much preoccupied with historic data instead of concentrating on the future, which was quite accurately predicted by subsequent inflation and GDP projections.

… further monetary easing justified

The process of gradual monetary adjustment will continue this year. With inflation on a downward path, interest rates will be brought down to at least 3.50% by the end of the first quarter.

In line with market expectations, at its January session the Monetary Policy Council lowered interest rates by a further 25 basis points. It was the third rate cut in a row, a continuation of the cycle of monetary easing that started in November 2012. In its press release the Council again raised the possibility of further rate cuts, but hinted that any subsequent adjustments would be conditional rather than automatic. The January statement notes that the RPP “does not exclude” (instead of “will implement”, as in earlier statements) further monetary easing, if incoming data confirm that the economic slowdown is durable. NBP governor Marek Belka devoted much time to this “slight” tweak of language during the press conference following the Council’s January meeting. He emphasised that the phrase should be taken to mean that “a certain round of cuts is coming to an end,” and that while a rate reduction in February “is possible, and even probable, it is not unconditional”. This prompted a clarification from RPP member Anna Zielinska-Glebocka, who explained that the expression about the end of the rate-cutting cycle was an unfortunate one and that what the Council meant was “a pause”. Asked whether the new language meant a change of policy bias, the NBP governor said the present stance remained intact for the time being, and that any shift from easing to neutral was possible only following an examination of first macroeconomic data for 2013.

As I mentioned earlier, the RPP pays close attention to incoming macroeconomic data. The set of figures for December showed a sharp weakening, not just of business activity (with e.g. industrial output contracting by more than 10% y-o-y), but also of private consumption (a decline in retail sales both in nominal and real terms), thus confirming earlier expectations that the fourth quarter of 2012 witnessed a substantial deceleration of economic growth in Poland (to about 0.5% y-o-y from 1.4% y-o-y in Q3), taking the growth rate for the whole year down to 2%.

In public comments made after the release of the December figures, RPP members openly emphasised the possibility of further reductions in interest rates, pointing to February as a very likely date of their next intervention. Contrary to their earlier remarks, a pause in the monetary easing cycle seems hardly justified at the moment, especially since the first quarter is likely to be the weakest of the year. This, and the new projection of CPI inflation and GDP growth due to be published in March, should persuade the Monetary Policy Council to make yet another rate cut in March. As in previous months, the rate reductions will be gradual (by 25 basis points each), which means that by the end of the first quarter the main rate will be down to 3.50%, a cumulative reduction of 125 points in the current loosening cycle.

This scale of monetary easing should be sufficient to stimulate the economy (though recovery in the eurozone, and particularly in Germany, Poland’s main trading partner, will be more important here) while keeping inflation near the NBP target. However, the possibility cannot be ruled out that, in response to very poor data raising the prospect of recession, the Council will implement more radical cuts, bringing rates down to as low as 3%. But before it does so, it will want to be sure that the cuts already made are having the intended effect of stabilising consumer prices in the medium term. And this will only be known in July, after the publication of this year’s second inflation projection.

Agnieszka Decewicz

Senior Economist, Bank Zachodni WBK

agnieszka.decewicz@bzwbk.pl



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