News in Charts: Poland inflation continues to ease, but for how long?

The Polish economy escaped with one of the mildest contractions in GDP during the COVID-19 pandemic, and followed that with a strong recovery, but over the past year it has been on a downward trend. Its trajectory was disrupted by the surge in global inflationary pressures, and this turbulence was severely aggravated by the start of the war in Ukraine, an event which affected Poland particularly. The highly inflationary environment (further exacerbated by an influx of 1 million refugees from Ukraine) has eroded households’ purchasing power, while higher input costs have severely constrained the industrial sector, one of the key engines of the Polish economy. As a consequence, private consumption and business investment have fallen sharply. Against this backdrop, exports have shone against all odds, despite an unfavourable external environment — mainly due to the resilience of the automotive sector. But this has not been enough to avoid the economy contracting in the second quarter of this year.

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The strong disinflationary trends in global supply chains and the ongoing domestic weakness are weighing down on inflation, which has been falling steadily over the past few months. However, the disinflation process in Poland still looks weak compared to other countries in Central and Eastern Europe. Since its peak, core inflation has fallen by only 2.1 percentage points (pp) in Poland, in contrast with a fall of 4.1 pp in the Czech Republic, 7.0 pp in Slovakia and 10.5 pp in Hungary. This clearly indicates that domestic factors are causing inflation to become more entrenched in Poland relative to its neighbours, and hints that the country faces a more challenging road ahead to bring inflation back to target.

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One of the key reasons for the large increases in Poland’s inflation rate has been the systematic policy mistakes made by the National Bank of Poland (NBP). In 2020 Q1, at the beginning of the pandemic, core inflation was already running significantly above the central bank’s target of 2.5%, an overshoot which continued for almost a year. Not only did the NBP downplay the importance of this, but it opted to cut the policy rate three times, leaving it at historical lows of 0.1%, while conducting expansive open-market operations. It was only in October 2021, with inflation already running at 7%, that the NBP changed its rhetoric and started raising rates, but at a slower pace than was required given the severity of the inflationary problem. Further, in September 2022 the NBP decided to pause its rate-hiking cycle, despite inflation not showing any signs of abatement. Indeed, inflation continued to skyrocket to reach a peak of 19% in February this year, almost eight times the central bank target.

Orthodox monetary policy typically argues that the policy rate should be set according to the outlook for two variables — the output gap and inflation. Adam Glapiński, the president of the NBP, appears to place greater weight on the former. Indeed he has a known aversion to positive real rates which he described as “killing” for the economy. To add fuel to the fire, the NBP has already started cutting rates. It did so last month by 75 basis points, surprising market expectations, and this week by 25 basis points, and has become the first central bank in Europe to cut rates despite having one of the highest inflation rates on the continent.

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The decision to cut rates appears even less justified when we consider that the economy, although contracting now, is giving strong signs of a turnaround. Industrial production has managed to return to positive territory after seven months of decline, while the services sector is also recovering — retail sales are gaining momentum and real wages are growing strongly, paving the way for an improvement in household disposable income and therefore in private consumption down the line. Despite the current weakness of economic activity, the labour market has remained quite resilient, with the unemployment rate currently standing at historic lows of 5%. This mainly reflects companies’ hesitancy to lay people off given the scarcity of talent in some sectors, an occurrence commonly described as ‘labour hoarding’. Perhaps not surprisingly, the NBP has recently downplayed these pro-inflationary developments, potentially setting the scene for a new policy mistake.

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The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.

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