The monetary policy set-up in Poland
The main objective of the NBP is to maintain price stability and, since 1999, inflation targeting has been used. From 2004, when Poland joined the European Union, the target has been for 2.5% annual inflation with a tolerance band of +/- 1 percentage point.
Policy is set by the Monetary Policy Council and the principal policy instrument, as in many countries with inflation targeting, is a short-term interest rate: the minimum yield on seven-day NBP money market bills. A corridor system is used to control money market interest rates more closely. The ceiling is given by the Lombard rate and the floor is given by the NBP deposit rate. The NBP uses required reserve ratios to smooth the impact of fluctuations in banking sector liquidity on interbank interest rates.
NBP policy during the Covid pandemic
The NBP responded quickly at the start of the Covid pandemic. In three meetings in March, April and May 2020, the Monetary Policy Council cut the policy rate by 140 bps to 10 bps and instituted an asset purchase programme (APP) and a programme allowing banks to fund new loans to enterprises. Overall, the presence of the NBP in the bond market had a calming effect with long bond yields declining despite the surge in crisis-related government borrowing.
In the 14 policy meetings following the interest rate cuts in 2020, the NBP kept interest rate unchanged at 0.10% and kept the various liquidity providing programs on the books even though they had ceased to be of critical importance.
A turn to tighter monetary policy
In response to economic activity recovering, labour markets strengthening and with inflation at 5.8% year-on-year, in October 2021 the NBP decided to raise interest rates by 40 bps to 0.50%. Further increases in inflation and stronger economic activity led to additional interest rate increases in November, December and January 2022, when rates reached 2.25%. After the last monetary policy meeting, the NBP signalled that further rate increases will likely be necessary to meet the inflation target.
This raises the question of what the neutral level of the real interest rate is in Poland, that is, when inflation is at the 2.5% target and the business cycle is “in neutral”.
One way to estimate this quantity is to look at the average real interest over some period. For instance, between 2005 and 2019, it averaged 1.3%. However, the average inflation rate was 1.9% in that period, that is, below the inflation target. This suggests that interest rates were too high for inflation to rise to the target, implying that the neutral real interest rate is somewhere below 1.3%.
Both headline and core (ex-energy) HICP inflation measures were weak in early 2019 but have since risen gradually and in December 2021 were far above the 2.5% target. This indicates that the high inflation rate in Poland does not only reflect sharp increases in energy prices but also the economic recovery. This argument suggests that the NBP will increase interest rates above its steady level of 3.6% for a period of time to bring inflation down to target.