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Interest rate cuts expected in the second half of the year. RPP to follow ECB’s lead

FINANCEInterest rate cuts expected in the second half of the year. RPP to follow ECB's lead

Discounts are expected, but they are likely to be delayed by a quarter. The European Central Bank (ECB) is likely to wait for decisions from the Federal Reserve (Fed), and the Monetary Policy Council (RPP) in Poland will follow the ECB’s lead. Three rate cuts are likely in Poland this year, but not until the second half.

The money market is currently pricing in a 52% probability of a 25-basis point rate cut by the Fed during its March meeting.

Just a short while ago, a March rate cut was perceived as a certainty. However, at this point, it appears that the earliest a cut could occur in the U.S. is May. If upcoming inflation, GDP, and PMI leading indicators illustrate the robustness of the U.S. economy, chances for a March rate cut could diminish further, potentially resurging the strength of the dollar.

There are still hopes for a faster-than-expected fall in inflationary pressure. In late January, Austan Goolsbee, the president of the Federal Reserve Bank of Chicago, announced that the bank’s decisions would be taken on an ad hoc basis. However, recent data reflected unexpected progress in the fight against inflation in the services sector. If this trend continues, it might pave the way for potential U.S. rate cuts. A few days earlier, another member of the Fed had stated that this year’s rate cuts were overestimated by the market.

“Central banks are very concerned about the possibility of inflation returning,” says Michał Stajniak, XTB expert, in conversation with MarketNews24. “Although they are convinced it will not be as high as in 2022 and at the beginning of 2023, the risk of inflation bouncing back is substantial.”

The money market continues to price in a 52% chance of a 25-basis point cut by the Fed in March. This outlook is not optimistic, considering that a week earlier, these rates were predicted at 77%.

The market expects the ECB to cut rates in April, with the likelihood of such a move estimated at just above 50%, down from nearly 100% before the holidays. Christine Lagarde, speaking at the Davos Economic Forum, announced that the ECB will have all the necessary information to decide on potential summertime cuts by mid-year. Consequently, the timetable for rate cuts seems to be drifting.

“The market initially approached the cuts euphorically, but it is now adjusting its attitude,” comments the XTB expert.

Several factors might delay rate cuts. The Fed holds four particularly important meetings per year, during which it publishes macroeconomic forecasts. Hence, if a cut doesn’t happen in March, the next likely term would be June. Although the ECB also receives quarterly forecasts, it makes decisions on a monthly basis.

“My guess is that the Fed would cut rates in June, and the ECB in June or July. The ECB will probably want to make its decision after the Fed,” assesses M.Stajniak from XTB.

Such a scenario will strengthen the dollar, a trend already observed in the second half of January. We have already noticed a significant weakening of the zloty against the dollar – over 2% since the beginning of the year.

Since the new government took office, the narrative of the head of the National Bank of Poland (NBP) has changed. He has become more cautious about optimistic inflation forecasts. The RPP’s actions are expected to be similar to the ECB’s.

“I expect the RPP will cut rates in the second half of the year, and it will do so three times,” predicts M.Stajniak.

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