A ROLLER COASTER RIDE
Updated: Jul 3, 2022
Forecasts have been revised upward where Poland will be one of the few countries (mainly in CEE) to go back to a pre-pandemic economic activity level as early as 2022. However, we are now back to the fear of a fourth wave. We have also seen a shift from NBP rate cut signals at the start of the year to rising rate hike expectations during the recent weeks. However, inflation and CPI momentum was the only area where we haven't seen a change in direction. Since December, inflation almost doubled the 2.4% year-on-year rate until May, with analysts' expectations pointing to a steady move-up for 2021 and 2022.
IS THE INFLATION GENIE OUT OF THE BOTTLE?
The inflation rate increase came to everyone's surprise in 2021. However, like other central banks around us, NBP bashed away the risk of a high inflation rate and called it transitory. The monetary policy community in Poland explained that with three arguments. Firstly, the base effect. Secondly, higher costs due to the pandemic and bigger acceptance for price hikes during economy reopening. And last but not least, if price growth is more persistent, it happens mainly/only in areas beyond the monetary policy influence. Arguably, the buzzword word of this year, "base effect," doesn't apply to Poland as prices in Poland weren't low in 2020. Almost all of the central banks following the Keynesian school consider only the demand side of the equation while assessing the economic situation, particularly inflation which isn't correct. Hence if we take energy prices, food, services, etc. it isn't really about the abundance or lack of currency units that would “alone” impact price. The supply that matters most, meaning a disrupted supply chain, increasing or restrictive production, regulation impacting supply will all drive less supply and higher prices even if the currency unit in the market remains constant. Hence, the inflation rate is beyond the MPC control, though increasing currency units would not necessarily help control inflation.
ONLY UP FROM HERE ...
The inflation rate will remain or go further up from here, putting it at a level higher than the MPC tolerance level of 2.5% +/-1%. The 4%is a new benchmark driven by the price increase of commodities and transport. Supply chain disruption is fueling further hikes and more stimulus packages in major economies would add more fuel to the fire to drive demand higher when supply is constrained. Looking at Poland, inflation will be supported by a healthy labor market, public consumption and the so-called “Polish Deal” government program.
The worries of a third wave decelerating economic growth proved unfounded. The economic activities resumed stronger than expected, with a robust forecast currently at 5% for 2021 and 2022, factoring in a negligible risk of a fourth wave, thanks to the faster than expected revival in demand components, particularly investment. The labor market also remains robust as we see firms hiring. The slack in the market started diminishing much earlier than forecast. Hence, wage growth continues its upswings, supporting household consumptions. CPI and core inflation remain elevated in H2 2021 and 2022. Some components are transitory but will be replaced by other, more fundamental conditions, resulting from a solid demand expansion and a tighter supply and labor market.
Following the change in the NBP president’s rhetoric pledging earlier, that rate will be unchanged "for long" or "until the end of MPC term of office." QE will live forever and thinking about policy tightening is "absurd" to a tone that reads: the NBP will not hesitate to hike when needed, rate hikes must be preceded by the end of QE, the tapering must take some time, preconditions for policy normalization are forecasts showing high and persistent growth, high and persistent inflation. It is undebatable that the MPC policy is turning towards a more data-driven decision matrix. Hence, the central bank may start rate hikes in November in reaction to a much optimistic economic scenario. The next forecast coming from the NBP will be key.
Moreover, an economic revival will help the government increase its fiscal revenue, where analysts expected the deficit to drop to 4% of GDP in 2021 from 7% in 2020. Hence, the potential of yields to start increasing following the NBP rate hike. It also means a stronger PLN where it is expected EUR/PLN to be at 4.51 at year-end with the risk of the Fed normalizing monetary policy, which will impact the broader basket of EM currencies, including PLN. Furthermore, the probability of NBP not changing course and the risk of dispute escalation between Poland and the EU causing sanctions and delaying EU fund delivery to the country are some other factors to be taken note of.
Despite considerable growth in household incomes, private consumption is still muted, especially when we read private consumption as a percentage of disposable incomes declined to an unprecedented level where the gap has been noted in saving rate that skyrocketed during the pandemic. Nonetheless, normalization is overdue, granting the expectation to see consumption seeing a double-digit growth rate soon, considering improving consumer assessment of the current financial situation supported by a robust labor market and wage increases. It means we will see further pressure on the demand side of the economy where analysts at Santander Bank expect that immediate normalization would boost Q2 consumption by about 25%. However, the report states that the process should be gradual with a total return to trend in 1H22.
In a recent report from Santander, the outlook for 2021 food prices has been revised from 1.7% to 2.3%. The meat market's primary drivers for an upward revision are higher fodder prices, higher demand and supply limitations as transportation, changes in regulatory frameworks, environmental disasters and disease outbreaks (bird flu, ASF). Other food categories such as grain and dairy prices are starting to point upward due to solid demand and limited supply. On the other hand, vegetable and fruit prices remain stable and muted thanks to strong crops in 2020. Nonetheless, following recent development in terms of heavy rain with the first information about drought coming in due time, we should expect a risk of higher prices in the second half of 2021 and the beginning of 2022.
Market prices have risen dramatically over the past few months. All forecasts read a persistent trend due to higher global CO2 emission prices per tonne, impacting Poland, mainly since most of its power plants are coal-dependent. Furthermore, the price increase for consumers’ energy consumption isn't only driven by higher commodities prices. It is also tax- and distribution-cost dependent. Hence, as Santander's recent report underlines, it makes forecasting retail prices less straightforward, though the upward pressure is evident by 10-15% for households, with rising regulatory pressure on fossil fuel energy sources and investment requirements for renewable energy sources. We will see more pressure on commodities’ prices and consequently on energy prices, at least for the medium-term outlook.