Exchange rates await Polish MPC move, the US dollar a hair away from a record high, euro at highest since March (Daily analysis 7.07.2022)

There will be a tenth consecutive interest rate hike - in fact, that is all we can take as certainty ahead of today's Polish MPC meeting. Fear of recession, weakening consumption, and a turnaround in commodity prices reduce the risk that inflation will be sustained at very high levels. This suggests that double-digit interest rates will probably not be needed to bring prices under control. At the same time, the decision will be taken when financial markets are in the eye of the cyclone, and the zloty is put to a difficult test. Yesterday, the euro breached 4.80 PLN. The dollar crossed 4.70 PLN and was a hair's breadth away from historic highs of more than two decades ago. Since the beginning of the month, the euro has risen by 1.5%, the franc by almost 3% and the dollar by almost 5%. Such a strong depreciation will not escape the attention of the MPC - today's move may determine the fate of the Polish zloty in the coming weeks.

The Polish zloty: MPC rate hikes at a key point

Connecting the dots: the trigger for the sell-off was natural gas prices in Europe. They have been rising for several weeks due to the reduction in Russian supplies. That sealed all the bitterness and made the fear of a global recession, particularly dangerous and real in the case of the Old Continent, prevail at the beginning of the quarter. As a result, another tsunami is moving through the financial markets, with the euro and other European currencies at the centre of it. The fear of a sharp deceleration in economic growth is matched by a series of data from Poland, which shows that the economy has lost momentum. The latest reading of the most important barometer of industrial sentiment, the PMI index, was a cold shower. This index shows that the sector is in decline, and its condition is worsening rapidly. Retail sales, for example, were also weak, and wage growth was no longer keeping pace with price increases.

The sharp deterioration in the outlook is still accompanied by record inflation. In June, consumer prices rose at the highest rate in 25 years. Their growth rate reached 15.g% year-on-year. Core inflation, excluding energy and food prices, exceeded 9.0% year-on-year. At the same time, it is far too early to make a credible diagnosis that price pressures have reached their highs and will ease off in the coming months. This makes the MPC face a challenging task at its July meeting. It can be said that the monetary authorities find themselves between the hammer of recession and the anvil of inflation.

The Polish Monetary Policy Council began a cycle of rate hikes in October last year and has already raised interest rates at nine consecutive meetings. The pace of tightening was intensified in response to Russia's invasion of Ukraine, which through a surge in fuel and food prices, had also added extra fuel to the fire of strong price pressures and raised the risk of very strong price pressures becoming entrenched. In Q2, interest rates were pushed up by as much as 250 basis points to stand at 6% at the end of the quarter. The recent suggestions that the cost of money could reach double-digit figures now seem much less likely to come true.

The zloty: rising exchange rates on the MPC's target

Conotoxia's previous forecast of the MPC raising rates to a target of 7.5% may also prove to be exaggerated. In the previous two months, rates were raised by 75 basis points and we invariably expect a repeat of such a move. However, given the decelerating economy, this should be the last such strong hike. In recent days, the likelihood has clearly increased that the Council may opt for a more modest move (50 basis points) or make a sharp adjustment right now to finalise the cycle.

The bad news is that this is not the result of disappearing inflation but significant economic outlook deterioration. This year, Poland's GDP should grow by around 4.5%. At first glance, this is a good result, but with the powerful economic momentum in the first quarter (the growth rate was 8.5% year-on-year), it raises the spectre of a technical recession, i.e. two consecutive quarters of economic contraction in a row. Moreover, GDP dynamics next year will remain very low, possibly not exceeding 2%. Such a scenario should be reflected in the National Bank of Poland's new projection. The MPC members will make their decision based on its content and it could edge the balance in key decisions.

Another factor that will influence the National Bank of Poland's move is the zloty's condition. The monetary authorities have expressed a clear preference this year for falling exchange rates to help fight inflation by driving down the prices of imported goods with a particular focus on raw material prices. Meanwhile, jittery markets and uncertainty are pushing the EUR/PLN to 4.80. This means that the euro has risen more than 20 cents in a month and costs the most since March. The dollar is outclassing the euro: the EUR/USD dived towards 1.02, pushing the USD/PLN up to 4.70 and towards historic highs. Today's MPC meeting (and tomorrow's US labour market data) will be decisive for the zloty. The fulfilment of our baseline scenario, i.e. a strong hike and no declaration that the cycle has come to an end, should turn out to be supportive for PLN. For the time being, the fact that the sharp rise in the euro exchange rate was halted at PLN 4.80, and the quotations returned under the peak from the second half of March can be seen as a positive element.