Poland's Dovish Shift: Navigating Rate Cuts, Inflation Risks, and Zloty Plays

The National Bank of Poland (NBP) has embarked on a cautious pivot toward easing monetary policy, cutting its benchmark rate to 5.0% in July 2025 after holding steady at 5.25% in June. This shift reflects a recalibration of inflation risks, with official projections now pointing to a steady decline in prices over the next three years. Yet, beneath the surface, a clash is brewing between the central bank's optimism and market skepticism about energy price risks and fiscal discipline. For investors, this creates a compelling opportunity to exploit mispriced inflation expectations in Zloty-denominated assets—but not without navigating a minefield of geopolitical and regulatory uncertainties.

The NBP's Dovish Turn: Data-Driven or Overly Optimistic?

The NBP's revised inflation projections are a central pillar of its policy shift. As of July 2025, it now expects inflation to fall to 4.0% in 2025, 3.1% in 2026, and 2.35% in 2027, down sharply from earlier forecasts. This optimism hinges on three factors:
1. Extended energy price caps: The freeze on retail electricity prices until September 2025 has dampened short-term volatility.
2. Swiss franc mortgage resolution: A May court ruling allowed households to convert CHF mortgages into Zloty at favorable rates, easing financial strain and curbing demand-driven inflation.
3. Base effects: The 2024 VAT cuts on food items are rolling off the statistical ledger.

Yet, the NBP's rosy outlook faces skepticism. Analysts at ING and others argue that its projections assume electricity prices will rise sharply in Q4 2025, which may not occur if the government extends freezes or wholesale energy costs remain subdued. Meanwhile, the central bank's “wait-and-see” stance—emphasizing risks like fiscal slippage and wage pressures—hints at lingering caution.

Market Skepticism: Why Inflation Could Be Even Lower

The private sector is betting that inflation will undershoot the NBP's forecasts. For example:
- Energy price tailwinds: Even if the electricity “windmill law” isn't finalized, wholesale gas prices have collapsed to €30/MWh from €100/MWh a year ago, potentially keeping retail prices stable.
- Wage moderation: May's wage growth slowed to 6.5% YoY, down from 8% in early 2025, easing pressure on core inflation.
- Zloty appreciation: The Polish currency has strengthened 5% against the euro since March, reducing import costs and further disinflationary pressure.

This disconnect between official and market views creates a prime opportunity for investors. If inflation undershoots projections—say, hitting 3.5% in 2025—the NBP could cut rates further, rewarding holders of Zloty bonds.

Investment Plays: Bonds and Currency

1. Short-Term Zloty Government Bonds

The NBP's forward guidance suggests it will cut rates gradually, with the terminal rate likely below 5%. Polish 2-year government bonds currently yield 4.5%, a premium that could narrow if inflation falls faster than expected.

Investors should consider long positions in short-duration Polish bonds, which are less sensitive to rate hikes and benefit from declining inflation.

2. Zloty Appreciation Against the Euro

The Zloty's recent strength is underappreciated. A weaker euro (EUR/Zloty at 4.35, down from 4.60 in March) reflects Poland's improving inflation dynamics and resilient growth. If energy price risks fade, the Zloty could appreciate further, especially against a backdrop of ECB policy normalization.

3. Short-Term Credit Default Swaps (CDS)

Poland's sovereign CDS spreads remain elevated at 120 bps, pricing in risks like a delayed EU budget agreement or a Russian gas cutoff. Investors could profit by shorting CDS if geopolitical tensions ease.

The Risks: Why This Could Go Sideways

• Energy price shock: If electricity freezes aren't extended, prices could spike, pushing 2025 inflation to 4.5% or higher.
• Fiscal slippage: Poland's structural deficit is projected at 2.5% of GDP, a red flag for bond markets if spending spirals.
• Global headwinds: Middle East oil conflicts or EU carbon pricing (via ETS2) could reignite inflationary pressures.

Conclusion: A Calculated Gamble on Polish Assets

The NBP's dovish pivot and falling inflation expectations create a favorable backdrop for Zloty-denominated assets. Bonds and currency are the clear beneficiaries, but investors must stay nimble. Monitor two key catalysts:
1. Energy price developments by late Q3 2025.
2. Fiscal policy clarity from Poland's upcoming budget.

For now, a modest overweight in Polish short-term bonds and Zloty/Euro long positions strikes a balance between upside potential and risk. But keep a close eye on the horizon—Poland's path to disinflation is still riddled with potholes.

Disclaimer: This analysis is for informational purposes only and does not constitute financial advice. Always conduct your own research or consult a licensed professional.