Analysis of Exchange Rate Trend (pln - Eur)

Analysis of a chosen exchange rate trend

Exchange rate under analysis: Euro against Polish Zloty (EUR/PLN)

The trend period under analysis: 1/12/2006 вЂ" 28/02/2007 (3 months)

Introduction

Following an approximate three-month trend of the Euro depreciating against the PLN up to the beginning of December 2006, the next period of over 2 months is of an upward trend. I will be analysing this upward trend and its causes, followed by a turnaround of the general movement. As the exchange rate goes from February 2006 through March 2006, a steady downward trend is developing, which implies a turnaround in future expectations at the end of the investigated 3-month period.

Leading up to December 2006

The Euro area

The growth rate of the Euro area has been relatively low for recent years, specifically not exceeding 2% from 2001 to 2005 . Nevertheless a significant вЂ?boost’ had occurred in 2006. A 2.7% growth rate in the second quarter provided expectations of even higher rates in the following quarter but weren’t reached with an actual result of 2.6%. Even though inflation slowed to 1.6% in October, the ECB expected a 2.4% annual inflation rate for 2006, an excess of 0.4 percent over its 2% target . As a result of this growth and inflation rate increase over the year, interest rates were increasing by 0.25% every 2 months since June until November 2006 (refer to appendix). At that time the ECB informed of its intentions to raise interest rates yet another 0.25%, up to 3.50% in December . Even though the Euro area had showed signs of slowing, the ECB’s rather “hawkish” policy implied the forthcoming increase may not even be the last.

Poland

Poland’s entry into the EU in 2004 spurred its already high rate of growth and is now enjoying significant inward investment as a result of membership. The average growth rate for the 1997-2005 period was approx. 4%. Poland’s record-low 4% interest rate had been prevailing for the past 8 months, stimulating consumer demand and corporate investment, according to a Bloomberg report of 30th Nov. Investments in the 3rd quarter of 2006 grew 19.8%, the fastest in seven years, while national demand gained 6.1%, strengthened through a 4.5% increase in total consumption. Industrial output grew 7.4% in the 3rd quarter, while construction output gained 14.8%, the fastest since 1997. Also mentioned in the report is a low inflation rate, recently the lowest of the EU, kept below the central bank’s target of 3.5% since May 2006 . In addition, consistent rises in the eastern European stocks have contributed to the relatively stable exchange rate trend during November 2006.

These indicators suggest economic health next to rapid development, which implies positive prospects for the Polish zloty in the near future. Yet at this point in time the upward trend of the PLN versus EUR has stabilised and is about to take the plunge. What is the source of this change?

The 3-month trend

We enter December with a strong expectation of ECB increasing interest rates. On Nov. 30th the European Commission raised its GDP forecast to 0.6% in the first 2 quarters of 2007 from a figure of 0.5% from the last 2 quarters of 2006. Given these expectations for the upcoming months, one would expect the value of the EUR to increase. Even though Euro zone interest rates well below that of Poland’s, there may be a possibility that they would exceed the Polish rates in the coming months?

Regardless of these speculations, the ECB reported an expected growth easing down to 2.2% in 2007 from 2.7% recorded for 2006 . These forecasts could be taking into account the contraction policy applied during the course of the year. In case of further raising interest rates, the EUR would increase in its value.

The Polish zloty is still looking strong at the beginning of December, fuelled by the countries growth, which its government forecast as a 5% rate for the year 2006. The rate of unemployment in Poland fell to 14.8% from 14.9% in October. A good sign, but this may force employers to increase wages and encourage inflation. The zloty had gained 4.3% versus the Euro in the past three months as indications of a quickening pace of economic growth continue.

This outlook was shaken by news of the deputy prime minister (also being leader of a party in coalition with the leading party) allegedly being involved in a sex scandal. If charged, he would face dismissal and changes in government would occur with the coalition being broken up. With lawmaker beginning the final debate on the 2007 state budget four days later, there is also a danger of the budget plan not being sufficiently supported. It needs votes of a majority of the 460 members of parliament. Without the coalition partners, the leading party would count on 153 votes, not enough to pass the project.

The zloty value against the Euro �dipped’ as a result of the news, strengthened by Euro interest rates being raised to 3.50%, then the zloty experienced a correction after the particular uncertainty had been lifted. On December 18th the PLN advanced against the EUR, approaching its maximum since March 2006. The main driver of this was the confidence in Poland maintaining strong growth through the following year. The approved Polish budget for 2007 assumed GDP growth of 4.6%, driven by a 5.1% rise in domestic demand and a 10% increase in corporate investment.

January started with latest inflation figure estimates turning out to be below those previously anticipated, and any prospects of seeing a rise in interest rates had faded. Another factor weakening the zloty was the uncertainty concerning the succession of the current governor of the Polish central bank. Balcerowicz, who implemented extensive policies to drag Poland away from a centrally-planned economy after the break-up of the Soviet bloc, had a great reputation. His highly “hawkish” approach also implied strict monetary policy during his period in office. Any replacement wouldn’t be as highly regarded and would probably incorporate a rather “dovish” policy, especially given the high-growth and low-unemployment focused government.

As a result the PLN dropped versus the EUR,