Why can we lose - because it's too loose ;-)

The interest rate environment in Poland (current benchmark rate of 1.50% unchanged since March 2015) is unprecedented for two reasons – firstly monetary policy has never been that stable and predictable; secondly, it has never been that loose. Guidance of monetary policy council members and statements of central bank’s governor is uniform – interest rates are going to stay intact for around two years. The monetary decision makers in their utterances point up they would sooner consider further loosening than jacking up interest rates; horribly.

Over eight years ago I wrote an essay in which I asserted why low interest rates are detrimental to the economy in the longer run. In that respect, my views have not evolved much over nearly a decade and I still fear the current near-zero real interest rates would do more harm than good to the booming economy of Poland. I do believe there are three reasons, why monetary tightening should be initiated right now, instead of waiting for dreadful stories to unfold.

Firstly, the wage pressure. Nominal wages in recent months were outpacing inflation markedly, reflecting not only rising efficiencies in production processes, but primarily labour force shortages in several industries. The salaries are rising predominantly among low-paid employees (partly side effect of 500+ allowance) whose supply is shrinking and employers are forced to compete for them. In that labour market niche pay rises reach 20% annually.

Effects?

1. Those people whose financial well-being has improved recently (good for them) would rather spend their additional income to have their needs met which generates additional demand on the market and might push up prices of basic goods.

2. Rising payrolls should drive prices of goods and services sold (otherwise profits of businesses decline or imported substitutes replace domestic goods.

Both effects contribute to increase in the price level, i.e. to future inflation.

Secondly, the situation on the property market, which is not in a bubble only thanks to record-high supply of new dwellings and several constraints on mortgage lending (which is pricey and subject to LTV restrictions and more stringent creditworthiness assessment).

The current bank deposits bring one-third of the income of property rental yield, so whoever is not afraid of risks and liquidity constraints associated with letting a flat does not keep their extra money on little-earning bank accounts and chooses to buy a flat for sale.

This also has several implications:

1.       Outflow of money from the banking system; whoever wants to invest in properties should realise unlike with a lending spree, here flow of new money might be cut short, as number of people with six-digit savings in Poland is finite.

2.       Increased supply of properties to be rented which might balance or not demand from tenants. In the final phase (especially after an interest-rate hike) the relative attractiveness of property rental might decrease and might trigger a sell-off from less experienced investors. This might as well go the other way round, as many people might be deprived of a chance to buy a property.

3.       Property developers have been increasing output of dwelling since 2014, so far with only marginal price increases. With current demand, surpassing supply and with increasing prices of construction materials and labour charges, property prices are set to rise inevitably with might not be put up with by buyers. margins in the industry will go down. Property developers as the group seem safe, however bankruptcies among general contractors and subcotractors loom large.

While until now the property market was generally heading in a good direction (increased supply of new dwelling, stable prices, higher availability defined as number of sqm can an average salary would buy), now the threat of imbalances has grown.

Worth noting other countries have already set off to increase interest rates, to somewhat dampen the economic boom and in many countries to stem double-digit growth in property prices which in longer run is dangerous to the economy and impoverishes the society.

I can moan, I can complain, while my grumbling will change nothing. I may only hope negative implications which I foresee do not materialise and the Polish economy does not suffer a shock.