Prof. Adam Glapiński: Average annual inflation in 2023 will remain elevated

For many years inflation in the world economy was low and stable. Although growth in consumer prices in individual countries varied, from 2013 onwards global inflation did not exceed 3%. Taking into account the long-term changes in the global economy, including globalisation of production and intensification of international trade, as well as the stabilisation of inflation expectations at a low level, it could have seemed that the times of high inflation were gone forever. Many economists were more concerned that the developed economies might even fall into a deflationary trap. However, these predictions turned out to be wrong.

Following two unexpected shocks – the COVID-19 pandemic and the Russian military aggression against Ukraine – since the beginning of 2021 global inflation has risen significantly and in many economies has reached levels not observed for decades. The initial factor behind price growth was the strong recovery in global economic activity following the recession triggered by the outbreak of the COVID-19 pandemic. This recovery faced supply barriers caused by insufficient production and hampered transport of commodities, as well as many other goods produced within the global supply chains. Previous decisions on phasing out the use of fossil fuels, particularly coal and oil, under the new climate policy also reduced the supply of commodities. As a result, the prices of commodities and many other internationally traded goods rose sharply. The later military aggression of Russia against Ukraine aggravated these disruptions, resulting in an acceleration of global price growth.

The significant rise in inflation in the majority of economies in the recent period therefore has roots in global trade. This in turn means that disinflation in not possible without measures on a global scale . In other words, major central banks have to take steps to reduce price growth. And these steps have already being taken. Since March, the Fed has raised interest rates significantly, and in July the ECB made its first interest rate hike in 11 years. Moreover, according to market expectations, these banks will continue the cycle of monetary policy tightening. Its effect will be a slowdown in growth, not only in the United States and the euro area, but – due to the existence of global trade links – also in the majority of the world’s economies. Weaker global economic conditions will also weaken global inflationary pressure.

The rise in inflation is a global problem, although its scale obviously varies. In the United Kingdom, the United States and in the whole of the euro area it reached approximately 9 % in the middle of this year, although in some euro area countries it was much higher. According to the estimates for July, in Lithuania, Latvia and Estonia inflation exceeds 20%. Differences in the scale of inflation growth may also be caused by structural factors, such as the structure of household consumption, the abundance of natural resources, the degree of openness of the economy, the level of energy consumption or the degree of dependence on Russian resources. The differences are also due to cyclical factors such as the situation in the labour market or the pace of the post-pandemic recovery in economic activity.

This last factor had a certain impact on inflation in Poland. Let me just remind you that our economy coped with the pandemic remarkably well and in the first quarter of this year real GDP had already exceeded the pre-pandemic level by 8%, while some economies, including Germany, had not even reached the pre-pandemic level. Such a dynamic rebound of economic activity is an undeniable success, although it also creates fertile ground for stronger price growth in the wake of global inflationary shocks. According to the final reading (for June 2022), CPI inflation stood at 15.5%. The bulk of inflation was the result of the direct and indirect impact of sharply rising global prices of commodities and intermediate goods. Eighty per cent of the change in inflation between February and July 2022 was due to the rise in annual growth of energy prices and prices of food and non-alcoholic beverages – in other words, goods whose prices react sharply to changes in external factors. Moreover, our estimates based on econometric models show that in Poland external factors are responsible for approximately 75% of the deviation of CPI inflation from the inflation target.

Nevertheless, there are also domestic, internal sources of the rise in inflation. The very favourable economic conditions in Poland and the dynamic post-pandemic economic rebound enabled firms to pass rising operating costs through to the prices of goods and services. As a result, apart from sharply rising prices of food and energy, Poles have begun to feel the price rises of a growing number of goods and services. This, in turn, has created the risk that consumers might get used to elevated inflation, becoming increasingly inclined to accept price rises and permanently adapting their wage demands to them.

Not wanting to let this happen, since October 2021 we have taken decisive measures, raising interest rates ten times, including the reference rate to 6.5%. It is obvious that our decisions do not affect global sources of price growth. However, they do contribute to weakening domestic inflationary pressure and can also accommodate the impact of external shocks on inflation expectations and – subsequently – on prices. Our decisions are therefore aimed at preventing the persistence of elevated inflation.

Looking at incoming data and the results of the July projection, we can conclude that the measures that we have taken are bringing results. According to the Statistics Poland flash estimate, in July 2022 consumer price growth in Poland was 15.5% y/y, and therefore remained unchanged compared to June 2022, which may indicate that inflation growth has slowed down. Significantly, at the same time the monthly growth rate of core inflation is declining. These data, along with incoming data from the global and domestic economy indicate more and more clearly that inflationary pressure will reach its maximum in this quarter and should decline in the coming quarters. Indeed, there are more and more signs of a downturn in the global economy. The US economy is in a technical recession and GDP forecasts have been revised downwards. In the second quarter of 2022, the economy of Germany – our most important trading partner – was in stagnation, and the latest monthly data indicate a slump in retail sales and a weak outlook for economic growth in the coming quarters. In Poland too, we can see the signs of a slowdown. In recent months, the PMI index, informing about sentiment in the manufacturing sector, has declined significantly. This has been accompanied by worse than expected readings of industrial output, construction and assembly output, and retail sales.

In short, data on economic activity support the scenario presented in the latest NBP projection, according to which Poland faces an economic slowdown in the coming quarters. Although we cannot rule out a temporary fall in GDP in quarterly terms, Poland certainly does not face an economic downturn. We expect a so-called “soft landing” and not for long, because after several quarters of weaker activity, in the second half of 2023 economic growth will once again pick up.

At the same time, even though they are temporary, the deteriorating economic conditions will weaken demand pressure and lower CPI inflation. We can say that inflation understood as an economic process has already reached its peak, although in statistical terms price growth may continue to be temporarily boosted by regulatory factors, including increases in electricity and gas tariffs related to the earlier increases in commodity prices. Among others, this is why, despite a gradual decline in 2023, average annual inflation in 2023 will remain elevated. However, in 2024 price growth will be lower and in the last quarter of that year it should return to around 3.5%, i.e. the upper limit of deviations from the inflation target.

At this point I would like to point out that although demand factors will be clearly conducive to a gradual decline in inflation, the forecasts of price growth in the coming months are still subject to very high uncertainty. This mainly concerns changes in the regulatory and legal environment. In particular, it is difficult to determine when and how VAT rates will be restored to their previous levels, which – according to the projection scenarios that we have presented – will have a significant impact on the inflation path. Moreover, the regulator’s decision regarding changes in electricity and gas tariffs following the dynamic increase in wholesale prices is unknown. Very strong increase in tariffs could cause the reading of CPI inflation in the first months of 2023 to be well above the inflation peak of 2022 and our projection expectations. However, an alternative solution cannot be completely ruled out based on only a slight increase in tariffs and the introduction of mechanisms to compensate trading companies for lower tariffs of gas and electricity sold to households. Prices of commodities, particularly energy commodities, which continue to change rapidly, are major market uncertainty factors.

Although significant for inflation developments in the coming months, the impact of these risk factors does not change the outlook for medium-term inflation, which will decrease as a result of the slowdown in economic activity in the world and in Poland along with the tightening of monetary policy by the central banks. From this perspective, it can be concluded that the measures taken so far by the Monetary Policy Council have been appropriate and effective, and in the light of the current data and forecasts, ensuring medium-term price stability will not require further, strong monetary policy tightening.

The article by the Governor of the NBP, Professor Adam Glapiński in “Super Express” (August 12, 2022): Average annual inflation in 2023 will remain elevated