READY, STEADY, GO!

Polish złoty (PLN) slumped to its lowest level in 12 years versus the euro in November as it faced pressure from geopolitical and economic risks in Central and Eastern Europe (CEE) on the one side and strengthening of the US dollar (USD/$) and Swiss franc (CHF) on the other side. As the National Bank of Poland (NBP) is expected to hike rates, the country’s legal tender has started recovery. However, currency markets are volatile as investors look for clarity on the new coronavirus variant Omicron.

NBP governor Adam Glapiński, explaining the reasons behind the weak złoty, said that a strong dollar generally leads to a decline in CEE currencies and the pandemic affects the moods in the financial markets. In November, USD went above PLN 4 mark, the highest since May 2020, when Poland was facing the first wave of Covid-19. Versus the euro (EUR/€), PLN fell to 4.7, hitting the lowest since 2009.

The dollar has strengthened as the market expects that the Federal Reserve will start hiking rates mid-2022 and solid economic data reassure investors about the recovery of the economy. Jerome Powell’s reappointment as Fed’s chair added confidence in prompt response to inflation as he is widely seen as more hawkish than Lael Brainard, who was the other candidate. The Omicron variant, however, puts pressure on the dollar as it could affect the timing of the top US bank’s plans to raise interest rates.

Meanwhile, Glapiński signaled that the NBP won't tolerate further currency depreciation. The Polish top bank increased the reference interest rate three times in a row in the last three months, lifting it to 1.75% at the December meeting, the highest since 2015. In December, the NBP raised the key interest rate by 50 basis points, in line with market expectations, after a 75 basis points hike in November.

During a week before the last central bank’s meeting, złoty has been recovering versus the euro. However, after the decision was announced on December 8, Poland’s national legal tender weakened again as some investors expected a higher rate hike. 

EXTERNAL DRIVERS

PLN recovery depends a lot on external factors as the decline was a part of a wider trend in Eastern Europe. Recently, the currency was among the worst performers together with Hungarian forint (HUF), Romanian leu (RON), Russian rouble (RUB) and Belarussian rouble (BYN). Investors who used to see the region as relatively stable now worry about geopolitical tensions and inflation pressure.

Polish Prime Minister Mateusz Morawiecki called the crisis at the Belarus border “the greatest attempt to destabilize Europe in 30 years,” tensions between Russia and Ukraine escalated again, the Romanian government collapsed and Brussels is in a dispute with Poland and Hungary over democratic principles.

The International Institute for Democracy and Electoral Assistance (International IDEA) said in November that many democratic governments are adopting authoritarian tactics by restricting free speech and weakening the rule of law amid the Covid-19 pandemic. “This includes established democracies such as the United States, but also EU member states such as Hungary, Poland and Slovenia,” International IDEA warned.

The European Commission and Poland have been stuck for months over unlocking €36 billion in grants and low-interest-rate loans under the EU's pandemic recovery program as Brussels accuses Poland’s ruling Law and Justice (PiS) party of undermining judges’ independence. This happens as Poland’s public debt accelerates sharply, putting additional pressure on the country’s legal tender. Meanwhile, there are concerns over possible lockdown in Germany, Poland’s main trading partner due to the rising number of coronavirus cases.

At a December conference Glapiński presented more hawkish rhetoric than in previous months, indicating further interest rate rises, ING analysts said. They expect one to two hikes by 50 basis points to 2.25-2.75% early next year.

WHAT DOES A WEAK Z˚OTY MEAN?

Glapiński admitted that there is no strong economy without strong złoty. The weak national currency leads to growth of prices for imported goods, higher cost of servicing foreign debt, and may scare off international investors. In addition, it reduces the purchasing power of Polish citizens abroad, which means, for example, that going for a holiday to another country is now more expensive than it used to be.

On the bright side, a weak złoty helps exporters as they can set a higher price in local currency for the foreign buyers. However, it’s not good for domestic customers who also have to face rising prices as lower value means increased cost of imported materials that are used to produce locally.

The prices of materials started growing due to bottlenecks in supply chains around the globe, which mean a shortage of goods and components and weakness in national currency further accelerated the trend for Polish producers. In October, producer prices jumped by 11.8% year-on-year, showing the steepest increase since November 1997, according to Statistics Poland (GUS) data. In this way, weak legal tender adds to inflationary pressure in the country.

Even though złoty was lagging compared to other emerging market currencies this year, the central bank head warned against comparing the PLN trajectory to the Turkish lira (TRY). “It is completely unjustified to compare Poland's economic situation to the situation in Turkey. They are just two different worlds,” Glapiński said in an interview to Interia.pl web portal.

As an argument, he used the yield of 10-year treasury bonds that indicates debt servicing costs and amounts in Poland to just over 3%, while in Turkey it is about 20%. However, he did not mention that real yields — the interest rate once inflation is factored in — in Poland is among the most negative compared to other emerging economies.

The trajectory of złoty to a large extent depends on the top bank’s further steps. Glapiński said that there is room to increase interest rates but it is not unlimited. “We cannot stifle the economy due to a possible increase in unemployment,” he said in an interview to Gazeta Polska newspaper, which was published after widespread criticism of the NBP for being too slow in hiking interest rates.

Central banks all over the world face the trade-off between inflation and unemployment as a hike in interest rates slows down the economy and cools the job market. Lower rates, in turn, generally lead to more job offers but as the economy grows the inflation speeds up.

The inflation rate in Poland jumped to 7.7% y/y in November, the highest level in more than 20 years, a flash estimate of GUS showed. According to Glapiński, inflation will remain elevated in the coming months due to external drivers, such as a jump in energy commodity prices.

He, however, added in December that NBP is satisfied with the current value of złoty, adding that the central bank intervenes only to prevent sudden jumps in exchange rates.

“There is no goal of weakening or strengthening the currency,” he said.