More and more countries around the world are now facing outright deflation and consequently central banks have continued to cut interest rates and most major economies' central banks have already hit the zero lower bound (ZLB) on interest rates. Increasingly, this is also the case for emerging markets, particularly in Central and Eastern Europe.
The Czech Republic is already at the ZLB and, in our view, it is very likely that in the next 12-24 months both Poland and Hungary could see interest rates inching close to the ZLB. This means that more and more central banks will have to consider other options. One possibility is Federal Reserve style quantitative easing but for small open economies it might be more logical to use the exchange rate channel and ease monetary policy by intervening in the FX markets.
We have already seen the Swiss central bank put a floor under EUR/CHF and the Czech central bank has introduced similar measures. It is not a given that other central banks will do the same thing but, in our view, with more and more central banks at the ZLB, FX intervention is becoming increasingly likely.
The most likely candidate to follow the example of SNB and CNB is the Bank of Israel (BoI). Inflation expectations have fallen in line with the global trend over the past few months and the Bank of Israel is effectively stuck at the ZLB. We have already seen it intervening in FX markets and we would not rule out more intervention to weaken the shekel in coming months. Indeed, we would place a fairly high probability on the Bank of Israel putting a floor under USD/ILS before the end of next year. Unlike in the case of other central banks, we believe the Bank of Israel is not facing any 'mental' or institutional constraints to introducing such a policy.
NBP likely to stay on hold but more rate cuts in the pipeline
There is high uncertainty about next week's rate decision in Poland. Even though we expect the NBP to take a breather after the surprise 50bp rate cut in October and stay on hold next week, we also acknowledge that there is a high chance of a 25bp rate cut next week. We would say that the chances are 50:50. Overall, signals from the NBP Monetary Policy Council (RPP) members are quite indecisive. If the NBP decides to stay on hold next week, we expect a rate cut in December and more to follow next year. We would not rule out Poland being forced to cut close to zero to stem deflationary pressure and the economic slowdown. Indeed, looking at our inflation model if the NBP does not act more swiftly suggests Poland will face even stronger deflationary pressure next year than it has until now.
Hence, we look for further rate cuts in Poland, if not next week then in December, and believe more is to come next year. Given the outlook for Polish monetary policy, we look for more weakness in the Polish zloty on the back of this.
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