Financial markets favor extremes. In their optimism, they can fall into overly high expectations, as is the case with decisions on lowering interest rates. For Poland, they forecast three cuts by mid-2024.
Clearly decreasing inflation provides room for interest rate cuts, although central banks themselves say that the fight against high prices is still ongoing, which could simultaneously lead to the suppression of the economy.
“Inflation is falling quite strongly, but we must remember that we are dealing with a base effect, and this effect is already exhausted,” says Michal Stajniak, an expert at XTB, in a conversation with MarketNews24. “Central banks quite clearly indicate however, that the inflation target will not be met in 2024, while markets are very aggressive in their assessment.”
How does the market view cuts in the USA, the eurozone or the UK? In the UK, inflation fell quite sharply to 3.9% YoY from 4.6% YoY, (a smaller decline to 4.3% YoY was expected). On a monthly basis, we have a drop in inflation to 0.2% MoM, although a slight increase to 0.1% MoM was expected. Obviously, we are still very far from achieving the 2.0% target, as the effect of an exceptionally high base rate is ending, but at the same time, we have an increase in market pricing for upcoming rate cuts. Before the inflation publication, the market priced a 25% probability for cuts in March. Now it is almost 40% and the market expects the first rate cut to appear by May.
Evaluations for cuts are also increasing in the eurozone, though Christine Lagarde, the head of the ECB, excludes the possibility of moves as early as March. For this month, the market assigns a 40% probability, but by April, the market sees even 1.5 cuts. This may be driven by the publication of producer inflation in Germany. Deflation there is still noticeable, though it has slowed down slightly. Germany’s PPI for November was -7.9% YoY compared to expected -7.5% YoY, with the previous level at -11.0% YoY.
The market is even more extreme when looking at the USA. There, the fight with inflation was most successful, as the CPI for November fell to 3.1% YoY. The market prices the probability of a cut in March at over 75%! That is a lot. The market’s inflated expectations were tried to be suppressed somewhat by US central bank owners after the last December decision, but the effect is completely contrary. Goldman Sachs expects the Fed to lower rates 5 times next year! The key question is whether the cuts will be related to quickly returning inflation to the target, or new economic problems.
Markets are reacting with stock prices. The indices S&P500 and Nasdaq are reaching record levels. However, government bond yields are falling. The broad index of the Warsaw Stock Exchange is also reaching historical highs (it is near 80,000 points).
“In the case of Poland, we had an inflation peak in February, so in 2024 we will still benefit from the base effect, inflation may be relatively low at the beginning of spring,” comments M. Stajniak from XTB.
Expectations of a fall in interest rates in Poland are much weaker. The market almost unanimously excludes cuts in the first three months of the year.
In March, a new report from the NBP will be published. Now the market prices that by mid-2024 there will be three interest rate cuts of 25 basis points each.
“The RPP’s April decision could be particularly interesting,” adds M. Stajniak.
