The Future of Poland's Interest Rates

The future of Polands benchmark interest rate is a matter of some controversy at the present time. Poland's central bank raised its benchmark interest rate by a quarter point to 5.25 percent at its last rate setting meeting at the end of February, and this was its fifth increase since April 2007. The central bank is fighting a strong rearguard action in an attempt to combat Poland's steadily rising inflation. So while the Federal Reserve has been busy cutting U.S. borrowing costs in an attempt to fight off and salvage battle scarred bank balance sheets, and the European Central Bank has kept its main refinancing rate at 4 percent since June, Poland's rate has been on the up and up, raising the yield differential and with it the value of the zloty as investors come in to gain the extra yield on offer in what is seen as being a relatively stable economy.

Poland's zloty climbed to a six-year high against the euro at the end of last month after the central bank raised its main interest rate and said inflation may accelerate faster than its earlier forecast. The zloty in fact rose 2.3 percent advance in February, the most since October, ranking it as the second-best performer among 11 emerging-market currencies in Europe, the Middle East and Africa, after the Czech koruna. Since that time the zloty has dropped back slightly, but talk of more interest rate rises is only going to fire it up yet again. Piotr Wiesiolek, the newly appointed deputy governor of Poland's central bank, is well aware of this issue, and has been actively out and about in recent days stressing that he sees no need to ``intervene'' to weaken the zloty. Indeed Wiesiolek emphasised he sees "further room" for rate increases in Poland in an interview with the television station TVN CNBC Biznes earlier this month.

``February inflation is lower than expected, but still not as low as we would like it to be,'' Wiesiolek said. The ``cycle'' of rate increases may end within one year.

With the Monetary Policy Council due to meet on March 25-26, and with analysts generally forecasting another increase in borrowing costs by 25 basis points to 5.75 percent, not everyone is so naunchalant about the situation, and Stanislaw Owsiak - who is a voting member of the Monetary Policy Council - is quoted this morning as saying he saw a need for a pause in interest-rate increases to allow time to better evaluate the outlook for inflation after the bank raised borrowing costs six times in the past year.

Owsiak, who is among a total of 10 members on the rate-setting Monetary Policy Council, said he expected inflation to return to the central bank's target range of 1.5 percent to 3.5 percent at the turn of next year after it accelerated to 4.2 percent in February.



The zloty weakened to 3.5433 against the euro following Owsiak's comments (perhaps this was his intention) and traded at 3.5403 at 10:27 a.m. from 3.5429 late yesterday. The yield of the zero-coupon bond was at 6.32 percent.

Owsiak said he saw a ``great need'' for a joint effort by the central bank and the Finance Ministry to combat inflation, which was fuelled mainly by rising energy prices and accelerating wage growth.


He also said the central bank must not ignore the rate disparity between Poland, the U.S. and the euro zone. Poland's borrowing costs are currently 1.5 percentage points above the European Central Bank's benchmark and 2.5 percentage points higher than the Federal Reserve's.

``There is a discussion on how rate disparity impacts the zloty,'' Owsiak said. ``Excessive appreciation of the Polish currency would be harmful for the economy.''

Traders saw a 78 percent likelihood the Fed will cut its target rate by a full percentage point at today's meeting, futures on the Chicago Board of Trade showed. There is a 22 percent chance the rate will be lowered 1.25 points.

The zloty has gained 7.6 percent against the euro since the beginning of last year, rising to near a six-year high on Feb. 28 in the midst of fast economic growth and expectations the central bank will raise interest rates further. Owsiak said the strength of the currency was already hurting some exporters.