FX Outlook 2018 – PLN’s rally not over yet

by: Georgette Boele ,

In this publication: In 2017, the Polish zloty has been one of the strongest EM currencies. For 2018 and 2019 we expect more upside, especially versus the euro as strong Polish growth continues. With inflation rising towards the central bank target, we expect the Polish central bank to hike before the ECB in early 2019.

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2017 a strong year for the zloty…

For the Polish zloty 2017 was a very strong year. It has rallied by 5% versus the euro and almost 18% versus the US dollar. In short, it was one of few currencies globally that have outperformed the euro this year. There are several reasons for this. First, the Polish economy has experienced strong economic growth momentum. The Polish GDP number for Q3 shows 4.9% growth. Private consumption is the main engine behind this strong growth, together with ongoing resilient export growth. Recent economic data for the fourth quarter show strong growth in retail sales and industrial output. Second, investor sentiment towards the eurozone and Central and Eastern Europe have improved considerably since the start of 2017 because of lower perceived political risks and strong growth momentum. The zloty is a currency that thrives if investor sentiment is constructive. All this does raise the question whether the strong performance can continue in 2017?

More strength in 2018 and 2019 versus the euro

We expect the zloty to continue to outperform the euro in 2018 and 2019. It is likely that investor sentiment will remain constructive in our forecast horizon and this should support emerging market currencies and the zloty in particular. Moreover, we expect the Polish economy to continue to profit from above-trend growth in the eurozone. Household consumption is likely to remain strong as employment has risen steadily over the past year. The tightening labour market will increase average wages down the line. Furthermore, the government has supported household income by generous transfers to families with children, increasing official minimum wage rates and higher tax-free personal income thresholds. The effects of these policy measures have yet to materialise. Also, investments will increase as the EU-fund cycle continues in 2018-19.

While we have seen some moderation of inflation in 2017, it is still well below the central bank target of 2.5%. Adjusting for changes in volatile food and energy prices, the 12m core inflation was even below 1% in Jan-Sep 2017. We expect inflation to be pushed higher in 2018, as rising wages and robust imports will likely fuel further inflationary pressures.

The central bank of Poland believes that inflation will stay below target in 2018. As the central bank is broadly ‘dovish’, they want to avoid decisions that could slow down economic growth. We do not expect (gradual) tightening before the start of 2019, but expectations and signalling by the central bank will probably already come in the second half of 2018. This will trigger a strengthening of the zloty, barring any unexpected shocks triggered by political tensions with the EU. As we expect the Polish central bank to hike before the ECB in 2019 and by larger steps, the zloty should continue to outperform the euro in 2019. A risk to this outlook is a sudden appreciation of the Swiss Franc, as Polish households still hold a sizable magnitude of Swiss franc mortgages (23% of total mortgages). This may trigger a zloty deprecation as households have to convert zloty’s for Swiss Franc to repay their mortgage debts. In this case, the Polish government will step in and provide loan conversions and this will likely coincide with tighter monetary policy.