During Tuesday’s meeting, the Monetary Policy Council (MPC) will raise interest rates by 50 bp to 3.25% in the case of the main reference rate, although it is possible that there may be a stronger hike, e.g. by 75 or 100 bp, say Ebury analysts: Enrique Diaz-Alvarez, Matthew Ryan, Roman Ziruk, Itsaso Apezteguia. They expect that the central bank will strongly emphasize that the stabilization of the exchange rate is important for it.
Since the beginning of the Russian invasion of Ukraine, the EUR / PLN exchange rate has increased from around 4.60 to 5.00 (approx. 9%) and was at the highest level in history. The zloty depreciates even more in pairs with the US dollar and the Swiss franc due to their safe haven status. The NBP interventions last week did not put an end to the weakening of the zloty. The central bank’s attention should focus on the strengthening of the domestic currency, while the scale of the damage to the economy is still uncertain.
The consequences of the war in Ukraine are difficult to predict at this stage, but it is certain that the changes taking place in the commodity and currency markets will be conducive to higher inflation in the region, at least in the short term. At the same time, the risk to economic growth also increased, especially in the medium term. Central banks are in a difficult position – they need to address both of these issues, and the recipes for them are opposite.
The impact of the war in Ukraine on the currency market
The currencies of the CEE region have clearly suffered since Russia’s invasion of Ukraine. The zloty weakened to: 5.00 paired with the euro (lowest in history), 4.99 paired with the Swiss franc (lowest in history) and 4.61 against the US dollar (lowest since 2000). The scale of weakening in tandem with the Swiss franc and the US dollar is greater, as these currencies are considered safe havens and react inversely to changes in the market attitude to risk. In the context of inflation, a strong depreciation in tandem with the USD is particularly unfavorable, as this currency is of great importance in global trade (prices of most commodities are generally quoted in dollars).
Depreciation is a consequence of several factors, including:
– the proximity of the conflict;
– economic relations (especially with regard to the import of energy resources from Russia);
– the fact that the zloty is the currency of emerging markets, which means that it reacts negatively to changes in the assessment of market risk.
It can also be a consequence of the fact that:
– the zloty is a very liquid currency, and thus reducing investors’ exposure to the region may mean getting rid of assets denominated in PLN in the first place;
– fundamentally, Poland may be more sensitive to shocks due to the situation of the balance of payments (marked current account deficit) and still only moderately high interest rates;
– in the broad market there are unfavorable changes for the zloty (the decline in the EUR / USD exchange rate – which is also observed now – often contributed to a weaker zloty in the past).
Due to high market volatility, the market began to expect large-scale changes also in the future. Currently, it assumes that in the following weeks the daily changes in the EUR / PLN exchange rate may amount to an average of approx. 1%, more or less two or three times as much as in the previous months.
What can NBP do?
Two classic methods of defending the exchange rate are currency interventions and interest rate increases. The first action is usually treated as temporary, limiting excessive pressure in the event of market disturbances. It does not have any significant negative consequences, apart from the reduction of provisions. The second action is more difficult as it contributes to cooling down the economy. Nevertheless, in the case of persistent negative pressure on the rate, it is often the only way to prevent excessive depreciation, as it inhibits the outflow of capital and increases the costs of speculation on currency depreciation.
In line with our expectations, a strong sell-off of the zloty has already met with a reaction from policymakers. The National Bank of Poland has sold foreign currencies for zlotys three times (on 1, 2 and 4 March) in order to strengthen the Polish currency, which is a classic method of intervention on the currency market.
The government joined the process of defending the zloty: the Ministry of Finance on Wednesday, March 2, informed that “the funds at its disposal will be exchanged primarily on the currency market on an appropriate scale. The exchange of these funds at the NBP will be supplementary.” This information was announced after the suggestion of President Glapiński in early February that it was considering stopping the exchange of funds from the EU with the use of the central bank.
The MPC will raise interest rates by a minimum of 50 bp:
Before the war between Russia and Ukraine, it was natural to expect that the NBP would gradually shift to a milder one of monetary policy tightening, however, at present it has to take into account the turmoil in the financial markets and the pressure on the exchange rate, which generates additional risks.
We assume that during the meeting on March 8, the Monetary Policy Council will raise interest rates by 50 bp to 3.25%. The same is now expected by the consensus. We assume that each smaller move may have a negative impact on the zloty exchange rate. The market reaction will also depend on the tone of the statement from the meeting, as well as on the rhetoric of Glapiński during the press conference on the next day. We expect the central bank to strongly emphasize that the stabilization of the exchange rate is important for it.
Taking into account the situation on the currency market, we do not rule out, however, that there may be a stronger hike, e.g. by 75 or 100 bp. Such a move would probably be necessary for the zloty to strengthen and could give the currency market a strong signal that the central bank’s priority is to stabilize the exchange rate. A hike by 25 bp is in our opinion an unlikely scenario, too risky in the context of the zloty exchange rate for the central bank to decide on it.
The rates may rise more strongly:
Based on the valuations of derivatives, it can be said that the market currently assumes that interest rates in Poland will amount to slightly over 5% at the end of 2022 – these expectations are higher than before the conflict. However, it is worth bearing in mind that these expectations are currently subject to very strong fluctuations. The situation may change from day to day and will depend, inter alia, on on how the exchange rate will develop. If the zloty weakness persists, the market will probably price in stronger rate hikes: market interventions are an effective, but rather short-term, method of easing tensions.
From the point of view of the currency market, the longer the conflict lasts, the greater its escalation, the more severe the sanctions – the worse. We are currently in a shock environment. If the situation calms down or the market “gets used” to the shock, pressure on currencies such as PLN should ease. However, a long-lasting conflict may mean that the weakness of the exchange rate will require a stronger reaction of the monetary authorities in the form of larger interest rate increases.
The decision on the MPC policy will be announced on Tuesday (08.03). President Adam Glapiński’s press conference will be held on Wednesday at 15:00.
Source: Ebury and ISBnews
