Poland records first ever deflation

By bne IntelliNews August 14, 2014

Jan Cienski in Warsaw -

 

Poland revealed on August 13 that it fell into deflation in July for the first time in its modern history. The release from statistical agency GUS showed consumer prices dropped 0.2% on an annual basis last month, and the worry is that there's more economic damage on the way.

The poor inflation report, added to growing worries about the effects of the Ukraine crisis and Russian sanctions, increases the pressure on the central bank's rate setting council (MPC) to offer a further interest rate cut from the current record low of 2.5%. The MPC has said in the past that a short bout of deflation would be unlikely to lead to a change in policy, but the calculations are changing.

Specifically, the tit-for-tat sanctions between Russia and the EU are starting to bite. Food prices were among the main drivers cutting the CPI reading in July, and Moscow's block on EU food imports will hit Polish suppliers hard, suggesting oversupply in the upcoming months. That's only likely to prolong the weak inflation picture. 

Economists estimate that the Russian fruit and veg ban could knock more than a half-point from Polish GDP growth this year, leaving it around 3%. "It is very probable that the council will begin a new round of rate cuts," summed up Poland's mBank. That spells bad news for the zloty, which is already swooning thanks to Ukraine. 

Casualties of war

However, it's not just quantifiable data that is doing the damage. Now, the worry that Russian tanks could storm into neighboring Ukraine is giving investors pause for thought.

Piotr Kalisz, chief economist at Citi Handlowy bank, suggests to newspaper Dziennik Gazeta Prawna: "Every investor will think twice about investing in Poland simply because of the geographic proximity of the conflict, even if they are aware that we are not on the front line."

If an invasion does happen, analysts expect a swift reaction on the region's largest currency market. The zloty, trading on August 13 at around 4.18 to the euro and 3.12 to the dollar, could sag as low as 4.7 and 3.5 respectively, predicts Przeymslaw Kwiecien at X-Trade Brokers.

"If a Russian-Ukrainian war broke out in the nearest days it would be particularly bad for the zloty because there has already been an outflow of capital from emerging markets in the direction of the dollar," the broker points out.

However, its not just the Polish currency that's in danger. The Warsaw Stock Exchange (WSE) - the region's largest bourse - has already been battered by changes in the pension system. That, in combination with the effects of the Ukraine crisis on the Polish economy - not to mention the numerous Ukrainian companies listed - has seen the WIG, the WSE's broadest index, lose 1.7% over the last month.

However, analysts worry the stock market could take a tumble on broader investor fears. The same fears are stalking the deepest state debt market in CEE. Until now the government has had no problems placing debt, but that could change if the situation in Ukraine worsens.

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