- After surging to 4.6% in 2017, growth will slow to 4% in 2018
- Lower EU-funds hurt Poland’s long-term growth perspective
- Inflation remains subdued, despite the tight labour market
- NBP to keep policy rate on hold at 1.5% for foreseeable future
- Zloty under pressure because of deterioration of sentiment towards EM in general, weak data from the eurozone and prospects of lower EU-funds
- Zloty will recover later in the year but less than we had foreseen.
- Our new year-end forecast for EUR/PLN is 4.15 (old 4.10)
Economic cycle has passed its peak
Real GDP growth accelerated in 2017 to 4.6%, after growth had slowed to 2.9% in 2016 (and averaged 2.6% in 2012-2016). Growth was driven by private consumption on the back of a strong labour market and social spending. Strong domestic consumption also resulted in a boost in import demand. Despite strong export growth, aided by solid demand from the eurozone, net exports contributed negatively to overall GDP growth. Gross fixed investments recovered in 2017, after a sharp drop in 2016 driven by a cyclical fall in EU-funds. For 2018 we expect economic growth to remain solid on the back of steady demand from the eurozone and the continuation of incoming EU-funds. That said, we expect domestic demand to contribute slightly less to GDP growth in 2018. Support programs by the Polish government, such as the increase of the official minimum wage and higher tax-free personal income thresholds, were one-off gains in 2017. On balance, we expect Poland to growth by 4% in 2018.
Paying the price of a deteriorating relation
In the beginning of 2018, talks on EU’s next Multiannual Financial Framework (MFF) started. Within MFF all countries in the EU will decide how EU-policies will be financed from 2021 onwards, and how the available funds will be divided between countries. For Poland, we see several issues that may significantly lower future funds:
• Brexit. The UK contributed around 7% of the total budget and it is far from guaranteed that other wealthy member states will fully cover this after 2021. German European Commissioner Günther Öttinger has already said that he expected cohesion funding (a component of the total EU-funds) to fall by 5-10% compared with current levels.
• Lack of solidarity and weak bargaining position: Rule of law infringements and the refusal of taking part in the EU refugee relocation scheme, lowers the goodwill of net-payers such as Germany, The Netherlands and Scandinavian countries. While in the end the MFF is a unanimous multilateral agreement, net-receivers, such as Poland, do not have time on their side. The previous MFF negotiation took about two years. Should negotiations take much longer this time, that would basically mean a postponement of payments to net-receivers.
• Fundamental changes in the multiannual Financial Framework (MFF). The European Commission (EC) wants to end the strong reliance on GDP per capita as a means of determining funding levels, and want to replace it with a much broader set of indicators. These indicators would include youth unemployment, education, the environment, migration policies and R&D. In addition, the EC wants to make the funding conditional on compliance with EU law, including rule of law standards. This could potentially result in a major shift of funds from the CEE-countries to Southern-European countries.
EU-funds amount to around 3% of the gross national income in Poland and hence any reduction would materially affect economic growth. In 2015-17, cohesion policy funds accounted for around 50% of public investment in Poland. If Poland ends up getting less money from 2021 onwards, this will hit growth and public investment, which will also result in a decrease in private investment. In light of negative demographic trends (ageing) and a strong need for infrastructural investments, lower funds could potentially hurt Poland’s long-term growth perspective.
Despite strong growth in 2017, inflation has remained subdued
In 2017, deadline inflation rose to an average of 2%, driven by higher food prices. Adjusted for changes in food and energy prices, core inflation was below 1% on an annual basis. Since November 2017, headline inflation has come down again – despite strong growth in nominal wages and consumption – reaching 1.6% yoy in April. This suggests that the effects of wage growth have been more than offset by other factors. One of the factors is the strengthen of the zloty against the euro and dollar, resulting in lower import inflation. Furthermore, labour productivity rose by 3.1% in 2017, partly offsetting the rise in nominal wages as well.
Going forward, we think inflation will slightly pick-up in the coming months, but will not overshoot the Central Bank of Poland (NBP) target of 2.5%. From a demand-pull perspective, the tight labour market will continue to push nominal wages higher. However, the presence of a large group of workers which are not official registered (mostly migrants from poorer eastern-European states), seem to dampen wage pressures. Also the introduction of sizeable social transfers will continue to soften higher income aspirations. From a cost-push perspective, companies are currently producing almost at full capacity while inventories are broadly declining. Furthermore, since the latest interest rate hike by the Fed in March this year, the zloty has lost against the dollar, which if sustained for a while will result in higher import inflation. Our annual average inflation forecast for 2018 is 2%.
Policy rate steady at 1.5% for the foreseeable future
The Monetary Policy Council (MPC) of the NBP has held the key interest rate at 1.5% on April 11. Since the beginning of 2004, the inflation target has been kept at 2.5% with a fluctuation band of +/- 1 percentage point. The current inflation level (1.6% yoy in April) falls now in the band, but we have no indication that the MPC is about to lower rates. The NBP views a rate cut as an option of last resort. The NBP governor, Adam Glapinski, indicated that due to the subdued inflation and lower growth trajectory, the current low-interest policy (real policy rate currently around 0%) could continue quite some time. Moreover, reading different statements of MPC members, nearly all of them seem to prefer holding the policy rate at 1.5% for the coming four quarters.
Polish zloty under pressure, but soon support close by
Since the start of the year, the Polish zloty has declined by 2% versus the euro and the US dollar. Uncertainty about global trade, the rise in US Treasury yields and the comeback of the US dollar have weighed on emerging market currencies in general. However, there have been more specific factors for the considerable zlotly weakness in the recent days. First, the weaker than expected eurozone data have triggered concerns among investors that the eurozone economy is unexpectedly slowing. As a result, investors have also scaled down expectations about the Polish economy as the eurozone is an important export destination for Poland. Secondly, there is a serious risk that Poland will receive lower levels of EU-transfers from 2021 onwards, which will hit growth and public investment (see below). In a short period of time EUR/PLN has risen (zloty weakness) from 4.16 to close to 4.30 or by 3.3%. We expect that the rally in EUR/PLN will probably run out of steam in the area of 4.30-4.35. When worries about the eurozone growth calms down, the Polish zloty will probably recover again later in the year. We expect the recovery of the zloty to be less steep than we had foreseen. Our new EUR/PLN forecasts are 4.25 (end of Q2), 4.20 (end of Q3) and 4.15 (end of Q4).