Jan Cienski in Warsaw -

Poland's interest rate setting Monetary Policy Council (MPC) kept rates steady at its July meeting. But the council's hawkish rhetoric together with Thursday, July 26's inflation report predicting that inflation will likely top the central bank's 2.5% target in the fourth quarter point to further rate increases later this year, perhaps as soon as August.

In a statement published after the meeting on July 24-25, council members reiterated their view that inflation is more likely to surpass the target rate of 2.5% in the medium term than remain below it, which is regarded as a signal that the tightening bias is set to continue. The central bank's quarterly inflation report said inflation could near 3.5% in 2009 if interest rates stay flat.

"I believe that the raises in April and June will be successful, but there is a larger probability that they will not be sufficient," Andrzej Wojtyna, a moderate Council member, said in a recent interview ahead of the July meeting. "We would like to create a situation where further increases in 2008 will not be necessary."

Another council member, Halina Wasilewska-Trenkner, was quoted by PAP news agency as saying a further rate rise may be needed this year, though she cooled expectations of a hike as soon as August by saying the council feels in a more comfortable position because inflation should remain at the target rate for the next two or three months.

"There is still a higher probability that we will need to tighten policy further, although we are now in a comfortable situation in that inflation should be around target in the next two to three months," Wasilewska-Trenkner told PAP.

Overheating

After the two quarter-point increases – the first increases in three years - by the 10-member Council, the key interest rate now stands at 4.5%. Poland's economy grew at a 7.4% rate in the first quarter and estimates for growth in the second quarter are for about 6.0%. However, many economists estimate that Poland's non-inflationary growth rate is closer to 5.0%.

And the economy is already showing signs of overheating, which the MPC has noted in its recent statements.

Poland's statistical office said that inflation in June was an annual 2.6%, above that 2.5% target for the first time in two years. Inflation is expected to range 2.3-3.3% in the final quarter of 2007 (with a 50% probability), strengthening modestly to a range of 2.1-4.1% a year later, while for the final quarter of 2009 an inflation range of 2.15-4.5% is projected.

"The forecasts for 2007 and 2008 are of particular interest, since they were raised compared to the previous outlook in April, which had shown inflation ranging between 1.3-2.6% and 1.6-3.8% in the final quarters of 2007 and 2008, respectively," says Ralf Wiegert, an economist with the consultancy Global Insight.

Poland's trade deficit has also shown a worrying increase. Exports in the first five months of this year rose by 12%, while imports rose at 14.5%. A main cause is an increase in consumption, boosted by the strong zloty, says Malgorzatra Krzysztoszek, an economist for the Polish Confederation of Private Employers.

One of the most visible signals of the economy performing above capacity is the recent rapid increase in salaries. Wage growth in June was 9.3% in annual terms, up from 8.9% in May and more than many analysts had predicted. While salaries are rising, productivity is not keeping pace. An analysis by BPH bank estimates that unit labour costs will increase by an annual rate of 6% in June.

Unemployment is also coming down. It was 13% in June, below the rate in Slovakia and thus marking the first time in years that Poland does not have the highest unemployment in the EU. Many industries, especially construction, are experiencing shortages of qualified workers.

Wage increases are becoming an increasing problem for companies, especially foreign investors who had pegged Poland as a low-wage country when choosing to set up factories. Hak Bong Sung, an LCD television production plant manager for South Korea's LGE near the western Polish city of Wroclaw, laments that rapidly increasing wages are making it more difficult to plan for the future.

In South Korea wages are adjusted every year or two by small increments, but in Poland managers have to tweak wages every few months to ensure that workers to not move to other electronics firms setting up in the region or else join the millions of Poles working in Western Europe. "The wages have been an unexpected problem for us," Sung told bne.

The MPC's recently released minutes also show the Council is concerned about continued rapid increases in government spending, despite the strongly growing economy, and with increases in consumer spending.

The growth and wage numbers have united the normally divided MPC on the need to send a strong signal, overcoming the public doubts expressed earlier this year by the Central bank's dovish new governor, Slawomir Skrzypek, an ally of Lech Kaczynski, Poland's president, who has lambasted past rate rises for unnecessarily slowing economic growth.

Piotr Kalisz, chief economist for CitibankHandlowy, a division of US-based Citibank, says that recent comments by MPC members coupled with the release of new data shows that rates will likely go up, but not immediately.

Dariusz Filar, the MPC's leading hawk, said in July that the MPC will have a better idea of the state of the economy once August numbers are released.

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