The Polish central bank surprised the vast majority of analysts with a 25 bps. rate hike yesterday, yet the initial market reaction was surprisingly modest. Early in the morning FRA pricing showed that the hike had been nearly fully priced in and yields inched up only marginally (by 2-3 bps.) in the 5Y and 10Y segments after the council decided to mark its decision to the market rather than defy the expectations of economists (most of whom, us included, had been expecting the hike would take place in July). The hawkish communiqué which followed the decision proved enough to send yields north (also at the short end of the curve) later in the session though. The MPC stressed productivity gains were no longer fully compensating for wage growth – in this respect the rhetoric was little changed from what we have been hearing from rate setters over the last weeks - the tighter labour market conditions remained the major risk o price stability in the medium term. Nevertheless while in previous months the Council had been preoccupied by the cost effect attributed to the rise in wages, this time visibly more stress was put on the domestic demand impulse from improvement in the labour market.
The MPC also added that looser fiscal policy (social security contribution cuts in July and January 2008 and possible wage rise concessions in the public sector in the coming quarters come to mind) may result in increased inflationary pressure in the medium term. On top of this moderate Andrzej Wojtyna reiterated that the Euro 2012 football championships also came at an inconvenient time and that the potential scale and timing of the impact they would have on price stability would be closely scrutinized by the MPC in the coming months. As such the comment came in more hawkish than needed to justify the June hike. Nevertheless, while the chances of acceleration in the tightening cycle have indeed increased, the Council came short of pre-announcing a July hike.
While the market may start pricing in such a scenario (yields might continue to rise early today across the curve, primarily at the short end) we would tend to stay on hold for now rather than extend short positions in anticipation of a renewed upleg in yields. At the same time we stick to our scenario that rates will rise twice more in the coming quarters – we se the next hikes in September and November (which would put the reference rate at 5.0%), although we cannot exclude the possibility that the MPC will decide to go with another pre-emptive hike in July, which would put the year-end tar-get at 5.25%. All this reaffirms our longstanding LT bearish stance for Polish bonds and positive outlook for the PLN.