The last couple of years have been a rough time for the Polish zloty (PLN). Between February and October 2022 alone, the US dollar gained almost 25% to trade at a high of 4.9883 against the Polish currency. While some recoveries have been made in 2023, the zloty is still trading at a relatively unimpressive 4.2411 against the greenback at time of writing. But with markets appearing to react positively to the result of the October 2023 election, could next year be better for the zloty?
One of the reasons for the zloty’s decline since February 2022 is the outbreak of war in neighbouring Ukraine, which has had significant negative impacts on the Polish economy. The World Bank noted that the ongoing war in Ukraine has dampened prospects of a post-pandemic economic recovery in Eastern Europe and hit Poland’s growth prospects – a trend that has been reflected in the zloty’s weak performance on foreign exchange markets.
A July 2023 survey also found that the Russia-Ukraine war has had negative impacts on 63% of Poland’s manufacturers, highlighting the extent to which the conflict has problematised business activity in Poland. The war in Ukraine is likely to remain a downside risk to the Polish zloty and other Eastern European currencies because there is always the potential for an unexpected escalation to change the regional picture – a risk that foreign exchange traders will need to take into account.
Another reason for the zloty’s decline could be the strained political relations the government in Warsaw has had with its counterparts at the European Union in Brussels. The European Commission has threatened to withhold funds from Poland because of judicial reforms that began in 2015, which the Commission believes could undermine the independence of the judiciary and the rule of law.
Brussels has also alleged that the Polish government’s socially conservative policies on LGBT rights, for example, are contrary to the EU’s “core values.” Poland is the single biggest recipient of EU funds, receiving just under €12 billion in 2021. Losing this crucial source of income would inevitably have significant economic implications. Fears of this happening have potentially weighted on the zloty over the last year or so.
However, in the recent elections, Poland elected a pro-EU government led by a former President of the European Council, Donald Tusk. This has raised considerable optimism that the incoming government will restore warm relations with Brussels and therefore unblock the money the EU is withholding. In turn, this could give scope for the zloty to make some strong gains against the dollar. Markets reacted positively to the election, with the blue-chip index WIG20, the zloty, and bonds all strengthening in the immediate aftermath.
However, much will depend on the actions of the Polish central bank, which in recent months has made moves which suggest strengthening the zloty is not a key policy focus. Indeed, despite inflation in Poland still running at almost 10%, in September the central bank unexpectedly slashed interest rates by 0.75% to 6%. This prompted the zloty to fall almost 3%. Foreign exchange traders fear that the move suggests the central bank is more concerned with stimulating spending than reducing inflation or strengthening the zloty.
There is the possibility that the central bank could change course, particularly given it has come under fire for allegedly being too close to the ruling Law and Justice party (soon to be replaced by the Tusk administration). Many suspect their recent decision to slash rates could have been a government-prompted political ploy to try and boost the economy prior to the election.
Markets will be hoping, therefore, that more orthodox monetary policy will accompany the new government. If this is the case, it would seem likely that interest rates in Poland will rise in order to help bring down the rate of inflation. This would likely lead to a stronger zloty as, put simply, higher rates incentivise traders to hold the currency for longer to achieve greater yields.
While the war in Ukraine continues to be a major risk hanging over the zloty, there seems to be plenty of reasons to be optimistic of the currency’s chances as 2024 approaches. A pro-EU government could repair Poland’s relations with Brussels, smoothing over political risk and releasing billions of euros in funding to prop up the Polish economy, while the prospect of higher interest rates could further strengthen the zloty’s chances of making sustained gains.
Author: Harry Clynch
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