Polish central bank stuns with 75 basis-point rate cut, zloty plunges

The first point we would make here is that, while inflation has risen just about everywhere in recent years, the increase in developed nations such as the US appears structural as well as cyclical while, for many others, especially in the developing world, the problem is a cyclical one, not structural. The difference is largely due to demographics. Even before the pandemic that demographic factors constitute a real risk that inflation is higher in the future than it has been in the past.

In developed countries, the number of working age people is currently shrinking relative to the elderly at a much faster rate than we’ve seen before. What’s more, projections suggest that this will continue in coming decades and is, in itself, enough to suggest that wage and price pressure will endure. But if we add to this the turbocharging of these adverse demographics from the pandemic, in terms of a decline in workforce participation, illness, early retirement and more, we can see that wage and price pressures will be higher in coming decades than they have been in the past.

In addition, the extra layer on this particular inflationary cake comes from deglobalisation; a trend evidently in place before the pandemic but again turbocharged through the pandemic. But while these structural inflationary pressures will endure in major developed nations and regions such as the US, euro zone and UK, they will be far less prevalent, or almost non-existent in many emerging nations. This suggests to us that their rise in inflation, associated with things like higher food and energy prices, is cyclical rather than structural.

For this reason, the Standard Bank thinks that many have the right to cut rates as inflation comes down, even if the Fed and others keep rates stubbornly high. This being said, we are clearly reliant here on investors adequately recognising this difference and so cutting emerging market central banks and currencies some slack. The second point is that emerging market currencies should not be vulnerable to “early” rate cuts provided it is clear that the Fed, ECB, BoE etc are all on a path that will end with rate cuts at some point. Things will be different if, for instance, the Fed has to start lifting rates again significantly because of a renewed surge in inflation. In this case, countries that have front-run Fed rate cuts will see their currencies fall.

“We believe that major central banks will not have to re-start significant rate hikes and hence think that emerging market currencies won’t be penalised for ‘early’ rate cuts. In fact, as the Fed, in particular, turns the narrative from rate hikes to future rate cuts we might actually find that global investors are particularly attracted to those already on an easing path as they speculate that the eventual arrival of Fed rate cuts will unleash a powerful rally in risk assets”, said the Standard Bank.

So here are two reasons why countries that front-run Fed rate cuts should not see their currencies suffer as a result. However, the front-running carried out by the National Bank of Poland (NBP) has seen the currency fall. This highlights the crucial factor we have not discussed so far; which is that the case for lower rates must be justified. If cuts are thought to be starting for some nefarious reason, such as political interference, then currencies are likely to fall whether the central bank is ahead of the Fed or not. And disagreements within the policymaking committee, as we have seen in Poland, may only fuel this currency weakness.

In short, currency vulnerability is likely when rates are cut injudiciously but, as long as this is not the case, rate-cutting currencies should not falter badly even if the cuts come well ahead of the Fed and other major central banks.