NBP headquarters, Warsaw, Poland (Narodowy Bank Polski, CC BY-SA)
NBP says that global economic conditions remain favorable, despite weaker GDP growth in some advanced economies at the beginning of 2018. Besides rising consumer demand, sound economic conditions in many countries are also supported by stronger investment activity. Risk factors to the global GDP growth include higher oil prices than a year ago and changes in the United States trade policy.
The European Central Bank (ECB) keeps interest rates close to zero, reminds NBP. At the same time, the ECB continues its asset purchase program, and anticipates that it will last until the end of 2018, though monthly purchases will be lowered since September 2018. Moreover, the ECB expects its interest rates to remain at current levels at least through the summer of 2019.
According to NBP’s report consumer price growth in Poland remains moderate (it stood at 1.5 per cent in Q1’18, 1.6 per cent in April, and 1.7 per cent y/y in May) on the back of stabilization in domestic demand pressure and moderate inflation in Poland’s most important trading partners. At the same time, following a decline at the turn of 2017 and 2018, energy price growth rose, while food price growth weakened. The NBP’s survey opinions of both consumers and enterprises on future inflation have not changed markedly over recent months. Slightly lower are currently inflation expectations of economists surveyed by NBP, who continue to expect inflation running close to the NBP target in the coming quarters.
In the period March-May 2018 core inflation, despite a marked recovery in business conditions in Poland, was running below the March projection expectations. The relatively low rise in inflation in the current business cycle was largely the result of high competition in the domestic market and lower than in the past sensitivity of price changes to fluctuations in economic growth. NBP writes that this is connected with the ongoing globalization and growing extent and popularity of electronically supplied services.
CPI inflation in the current forecasting round will increase and will run slightly above 2.5 per cent in the years 2019-2020. According to NBP the increase in CPI inflation will be driven by rising cost and demand pressure in the Polish economy, which will have a delayed impact on prices. Costs of enterprises are raised over the projection horizon in particular by the elevated level of wage growth, exceeding labor productivity growth in real terms.
NBP forecasts that core inflation will also be boosted by higher demand pressure, reflected by the positive output gap persisting in the years 2018-2020. However, the sensitivity of price growth to changes in the domestic economic conditions has decreased in recent years, which is one of the reasons for the relatively slow growth in inflation in the current business cycle.
Yet, in the projection horizon CPI inflation will gradually pick up as a result of growing demand and cost pressure in the Polish economy having a lagged effect. With the absence of changes in NBP interest rates assumed in the projection, consumer price inflation in the years 2019-2020 will slightly exceed the level of 2.5 per cent. Corporate costs will be boosted by heightened wage growth, persisting over the projection horizon, which will exceed the rise in labor productivity in real terms. Increased demand pressure will also contribute to higher inflation, which will be reflected in the positive output gap persisting in the years 2018-2020. However, inflation in Poland will be curbed by moderate inflation abroad.
The expected by NBP projection scenario will be greatly impacted by future conditions in the global economy. Potential risk factors include a worsening of current trade conflicts and a further rise in protectionism in global trade as well as the risk connected with a potential sovereign debt crisis in Italy. Besides economic activity abroad, oil prices on the global market are also a risk factor for domestic inflation. The materialization of the abovementioned risks would contribute to a lower path of GDP growth than assumed in the central scenario, amid the symmetrical distribution of risks for CPI inflation, as reflected in fan charts for those variables
Apart from these circumstances, the inflation path over the projection horizon will also depend on the factors accelerating energy price growth in 2018-19. At the same time, with the easing of the unfavorable supply conditions in 2018, food price inflation will decline compared to 2017.
Domestic energy price inflation in 2018-2019 will be boosted by the delayed impact of the increase in energy commodity prices in the global markets recorded in Q2’18, accompanied by a depreciation of the PLN. From January 2019, energy prices will also be pushed up by the electricity bill hike resulting from higher costs of ensuring energy security and the support for renewable energy sources. The introduction of emission fee will, in turn, result in an additional increase in fuel prices next year. However, the expected end of the arbitration proceedings between PGNiG and Gazprom, which will lower the price of natural gas for households, will be a factor holding back energy price inflation.
Despite the inflationary impact of demand and cost factors, food price inflation will run below the level of 2017 over the projection horizon. This will be caused by the fading impact of the unfavorable supply conditions and the limitation of shortages in the markets of certain agricultural commodities and products, which led to an increase in the prices of fruit, vegetables, meat and dairy products last year.
Polish economy in 2018-2020
Following the decline in economic growth in the Eurozone, Poland’s GDP growth will also gradually slow from the high levels observed at the turn of 2017 and 2018. NBP writes in its report that household consumption will continue to be the main driver of GDP growth, in the years 2018-2019 the contribution of investment to GDP will increase, as a result of the need to rebuild the production potential of the Polish economy and the inflow of EU funds from the EU budget.
The steadily rising demand in the economy is driving up the demand for labor, which translates into a further increase in employment and decline in unemployment. As a consequence, bargaining position of employees in wage negotiations is strengthening which is reflected in a faster than in previous years growth in wages in the economy. At the same time, non-wage working conditions are improving. The stronger than in previous years wage growth is, however, accompanied by higher labor productivity growth resulting from an acceleration in economic activity. Consequently, unit labor cost growth remains moderate.
According to NBP economic conditions in Poland remain favorable. In Q1’18, GDP growth was close to that in the second half of 2017 (5.2 per cent y/y in Q1’18 against 4.9 per cent in Q4’17 and 5.2 per cent in Q3’17). It continues to be driven primarily by expanding consumer demand, which is supported by rising employment and wages, combined with very high consumer confidence.
At the same time, investment growth is gathering speed, though largely on the back of public investment co-financed from EU funds. Net exports contributed negatively to GDP growth in Q1’18, which was likely to reflect a temporary slowdown in the Eurozone economic activity at the beginning of the year.
In the first half of 2018, the Polish economy remained in the expansion phase—GDP growth stabilized at a high level close to 5 per cent y/y, with continued relatively high private consumption growth. Gross fixed capital formation also picked up significantly. The central and local government sector continued to be the main driver of growth in this category, while corporate investment remained low.
In the projection horizon GDP growth will gradually slowdown, predicts NBP. Private consumption will remain an important factor of growth in domestic demand, due to the continued improvement in the labor market situation, which has a positive impact on household disposable income and household sentiment. In the years 2019-2020 the role of investment in economic growth will increase, connected with the need to expand the productive potential of the Polish economy and the growing absorption of EU structural funds under the current financial framework 2014-2020. The low level of interest rates and the resulting low cost of credit will have a favourable impact on domestic demand. However, economic growth will be restricted by the slowdown in GDP growth in the euro area which is forecast for 2018-2020.
“It is not that difficult to see that Polish economy is in an rapid expansion phase. We are a bit surprised by the fact that GDP growth in H1’18 was higher than forecasted in the March projection. Despite this positive surprise we have been preparing the same scenario for at least two projections. And the scenario says that after this expansion there will be a slowdown in GDP growth. (…) The potential growth will be around 3.5 per cent, which means that the economy will balance itself,” said Piotr Szpunar, Director of Economic Analysis Department of Poland’s central bank, Narodowy Bank Polski.
According to NBP private consumption will remain the main driver of economic growth in the coming years. Household consumption will also be backed by low level of interest rates having a favorable impact on the cost of financing consumer spending with loans. At the same time, the child benefits “500+ Program”, which boosted consumption growth in the years 2016-2017, will have a merely limited impact on its growth in 2018. Additionally, higher inflation will curtail the rise in household purchasing power. Taking into account these determinants, consumption growth will gradually slowdown from its current high level over the projection horizon.
In 2018, investment growth will reach its peak in the current cycle with the central and local government sector being the main driver of growth. In the subsequent years, gross fixed capital formation growth will decline with a growing share of corporate investment and declining share of housing investment.
The high public investment growth in 2017 and at the beginning of 2018 was mainly driven by higher expenditure of local government units co-financed by the EU funds. The Ministry of Development data on agreements signed for the use of funds under the individual operational programs indicate that a further strong rise in capital expenditure of the general government sector can be expected in the coming quarters. In the years 2019- 2020, the annual inflow of EU transfers will continue to rise, although at a slower pace than assumed for 2018 , translating into a slower growth rate of public investment.
Both data from corporate financial statements, as well as data from national accounts indicate that enterprises are increasing their investment activity to a moderate extent. The current investment growth of those entities remains relatively low, despite a very high level of capacity utilization (declared both in NBP and Statistics Poland, GUS, reports), with the transport sector having the largest contribution to expenditure growth. Companies operating in this sector, with a majority share of public ownership, relying on EU funds in their activity, have increased investment. At the same time, the scale of investment in certain sectors is limited by the growing shortage of labor supply. The share of enterprises declaring job vacancies is high, and this problem is mainly reported by enterprises undertaking investment aimed at increasing productive potential.
Additionally, the possibility of replacing labor with capital seems–at least in the short-term horizon–to be perceived as limited by enterprises. In particular, in the industrial manufacturing sector the share of enterprises pointing to the shortage of machinery as a barrier to activity is approaching the historically low level amid a large share of companies reporting problems with finding suitable employees.
Growth in investment expenditure in the national economy over the projection horizon will be boosted by households’ housing investment. The residential housing market continues its expansionary phase, whereas demand, which has been on the rise until now, is met to a large extent by a high supply of dwellings limiting price growth. At the same time, transactions continue to be financed with a significant contribution of households’ own funds.
Growth in the number of employed persons will gradually slow down over the projection horizon. Currently, the determinants of demand for labor remain favorable; however, along with the slowdown in GDP growth, slower growth in demand for labor is also expected in the coming years. Growth in the number of employed persons will also be held back increasingly by the supply of employees. The number of the unemployed who could undertake employment is small, which is reflected in the record low and declining unemployment rate. Consequently, enterprises will continue to have problems finding suitable workers.
Wage growth in the years 2018-2020 will remain at an elevated level, exceeding the growth rate of labor productivity in real terms. On the one hand, wage growth will be boosted by the further decrease in the unemployment rate and the rise in consumer price inflation. On the other hand, over the projection horizon growth in demand for labor on the part of enterprises will decline, and wage pressure in the economy will be additionally alleviated by the presence of immigrants from Ukraine. The results of NBP surveys also point to a stabilization of wage growth in the coming quarters. According to the survey results, although the share of employees that will benefit from wage rises has increased and the value of the average wage rise has increased slightly, at the same time the percentage of firms forecasting wage rises has declined.
Current and capital account balance
In the years 2018-2020, following the decrease in trade surplus, NBP expects that the total balance of the current and capital account will decline. The expected higher growth in the volume of imports than exports will contribute to the deterioration of the trade surplus. The future path of exports will be largely impacted by declining economic growth in the Eurozone, including in Germany.
The ratio of nonfinancial sector debt to GDP remained broadly stable and at the end of Q1’18 stood at around 51 per cent. In Q1’18, the current account balance decreased slightly compared to Q4’17. This reflected a decline in the balance of trade in goods, as exports decelerated more than imports, which probably resulted in part from temporary factors. The capital account remained in surplus, supported by further inflow of funds under the Cohesion Fund and the European Regional Development Fund. As a consequence, the combined current and capital account balance stood at 1.2 per cent of GDP. In Q1’18, the financial account balance was close to that in the previous quarter, and amounted to 0.1 per cent of GDP. The balanced financial account was accompanied by a reduction in Poland’s foreign debt. Also other indicators of external stability evidence that Polish economy is well balanced.
The relatively higher import growth will be driven by growing investment demand in the Polish economy, including rising corporate expenditure, which is characterized by a relatively high import intensity. The decline in the trade surplus will also be driven by a less favorable terms of trade, mostly related to rising prices of energy commodities in the global markets. Rising wages of immigrants (primarily from Ukraine), working on a temporary and seasonal basis in Poland, will also contribute to a deterioration in the current and capital account balance. The fall in the current and capital account in the years 2018-2020 will be partly mitigated by the growth in the surplus in the capital account related to the growing inflow of EU investment funds under the EU financial framework 2014-2020.
Taking into consideration macroeconomic conditions, the Monetary Policy Council keeps NBP interest rates unchanged, including the reference rate at 1.50 per cent. In the recent period, market expectations on NBP interest rates have lowered and indicate a stabilization of interest rates in the coming quarters.
In recent months, government bond yields in Poland have been relatively stable, while equity prices have declined, following a marked fall in stock indices in other emerging markets. The decline in equity prices took place despite favorable signals regarding economic conditions in Poland. Amid deteriorating sentiment in global financial markets, the exchange rate of the PLN weakened, after an earlier strengthening. In turn, the expansion phase in the residential real estate market continued. This has not generated any major tensions thus far. Growing activity in the market was accompanied by slight increases in home prices.
In Q1’18, growth of the broad money aggregate (M3) picked up slightly compared to Q4’17. Growth in the value of household deposits still made the largest contribution to the M3 growth, while the increases in corporate deposits and cash in circulation were of a minor importance. Stable growth of loans to the nonfinancial sector, which for several quarters has been running somewhat lower than nominal GDP growth, continued to be the main driver behind the creation of broad money.
This inflation and GDP projection was prepared by the Economic Analysis Department of Poland’s central bank, Narodowy Bank Polski and presents a forecast of economic developments under the assumption of the unchanged NBP interest rates. The July projection based on the NECMOD model covers the period from Q2’18 to Q4’20. The starting point for the projection is Q1’18.
The full report can be found here.