Recent data releases from Poland suggested, in our view, that the GDP growth slowdown in the final quarter of 2014 was still relatively mild. We have raised our GDP forecasts slightly, to 3.1%YoY in 4Q14 and 3.3% on average for the full year (from 2.9% and 3.2%, respectively). We expect the growth slowdown to be temporary. Most of the risks continue to be external, with a number of question marks hanging over the Euro zone economy and considerable difficulty in forecasting further developments in Ukraine. Domestic demand became an important driver of GDP growth last year and is likely to remain so in 2015, offsetting a large part of the negative impact of faltering external demand. The improvement in the labour market should continue, with job creation and notable growth in real wages (supported by productivity increases).
Inflation has dropped further and further below zero. According to our forecast, CPI fell to nearly -1%YoY in December and may fall even more at the start of 2015, dragged down mainly by plummeting fuel prices and cheap food. We think inflation will remain in sub-zero territory until the end of 3Q15. While we see lower prices of basic goods as strongly supportive for private consumption, as they leave a substantial amount of money in households' pockets for purchases of discretionary goods and services, the idea that headline CPI could be deflationary for more than a year, and may not return to the 2.5% target before 2H16, will create pressure for the central bank to ease again.
The Monetary Policy Council (MPC) kept interest rates on hold in November and December. However, given the inflation outlook, we think additional easing is quite possible. This looks unlikely to be at the start of the year, as recent economic data (still quite decent) and the year-end zloty depreciation offer little to help convince the majority that additional easing is needed. The Council is deeply divided, but we think the scale and the length of deflation will surprise the central bankers and may tip the balance towards more easing, probably in March, when the new NBP projections are due to be released. We expect a 25bp cut. There is a downside risk to this scenario, but we do not see easing of more than 50bp in 2015E.
The short end of the yield curve should remain quite stable in the near term, as deeper deflation should be offset by steady interest rates and still-solid economic data. Meanwhile, the belly and long end may drop further, on anticipation of quantitative easing by the ECB. Assuming the ECB launches its additional stimulus in January, a correction is possible at the end of the month. The zloty's depreciation at the end of December was excessive, in our view, exacerbated by extremely low liquidity. Quite decent macro data and no rate cut in January, plus hopes of QE, should support the zloty versus the euro. Meanwhile, USDPLN may increase further as the downward trend in EURUSD is probably not over yet.