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Wednesday, December 5, 2007

The Rise and Rise of the Zloty

The Polish zloty gained again today, rising a 5 1/2-year high against the euro as risk appetite improved and investors bet the interest-rate difference with the U.S. will widen. The zloty, which has been the best performer in a group of 26 emerging-market currencies, has gained 6.2 percent since April, when the central bank began raising its reference rate in four quarter point stages to its current 5 percent level . Federal Reserve Vice Chairman Donald Kohn has recently acknowledged the threat to US consumer spending which could result from a reduced access to credit, stoking expectations that the Fed will lower interest rates for a third straight time on Dec. 11.

The zloty rose as much as 0.2 percent to 3.6036 per euro today, the highest since May 2002, and was at 3.6070 by 11:31 a.m. in Warsaw, from 3.6121 late yesterday. All of this raises important questions about the actual ability of conventional monetary policy to work in Poland, since raising rates may just as easily stoke up more inflation - as we have seen in Australia and New Zealand, and to some extent in China - by attracting more investment funds into the country. This issue became apparent when the zloty also gained after a central-bank policy maker Marian Noga said the interest rate may have to rise as much as three-quarters of a percentage point before the end of 2008 to ward off inflation. Normally, an impending rise in inflation and a monetary tightening process (which reduces growth) would be considered to weaken and not strengthen a currency.

``The sooner we have the hike, the better, as preventive action is
cheaper than boosting rates to chase down inflation,''
Marian Noga.

Faster-than-expected economic growth in the third quarter and a drop in unemployment have increased the chances inflation will breach the 3.5 percent upper limit of the central bank's target. The inflation rate, which rose to 3 percent in October, first exceeded the target's 2.5 percent midrange in June.

Noga said the repurchase rate may have to rise to between 5.5 percent and 5.75 percent in quarter-point moves to quell consumer- price growth. ``Moves by 25 basis points are reasoned and balanced,'' Noga was quoted as saying in an interview in Warsaw.

Growth continued at the strong annual rate of 6.4 percent in the third quarter of 2007, according to data released by the Warsaw-based National Statistics Institute earlier this week. Year on year retail sales rose in October by 10 percent, while sales of manufactured goods increased 14 percent on year in October.

Not everyone in the central bank agrees with Marian Noga, however. Monetary Policy Council member Miroslaw Pietrewicz has said that Poland's central bank should delay raising the benchmark interest rate until policy makers assess whether four increases this year have contained inflation.

The increases are ``a lot and the first results could be visible in the second half of next year,'' Pietrewicz, 66, said is quoted as saying in an interview earlier today in Warsaw. "Inflation is currently driven by factors that cannot be influenced by monetary policy", while any further increases "could boost inflationary expectations."

Pietrewicz's comments may signal a split in the council about the future direction of monetary policy and is an indication of the difficulties the central bank will have in controlling inflation in the years when Poland is trying to enter a euro adoption process.

Poland's inflation rate, which was at 3 percent in October, probably reached the 3.5 percent upper limit of the central bank's target in November because of rising food costs around Europe, the Finance Ministry said on Dec. 3. The Organization for Economic Cooperation and Development said today Polish consumer-price growth will accelerate to 3.6 percent next year.

Pietrewicz takes the view that such predictions don't necessarily "require a reaction from us, because first of all, we need to be sure that this acceleration is not a one-time jump generated by food prices, as it was in October"......."It's too early to figure this out in December".

The government also plans to reduce the budget deficit to 27 billion zloty ($11 billion) from the targeted 28.6 billion zloty.

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