The Polish zloty awaits the elections outcome

In the first part of October, the Polish zloty was recovering from its September depreciation, with exchange rates dropping sharply. The EUR/PLN exchange rate not only sank below 4.60, but in the middle of the week came close to 4.50. The USD/PLN exchange rate dropped by several per cent in one week and returned to 4.25 for a while. The first impetus for the recovery of the Polish currency was the Monetary Policy Council (MPC) meeting, which refrained from cutting interest rates by more than 25 basis points. The positive trend was later fuelled by a sharp improvement in global financial market sentiment and a halt to the sell-off in government bonds. The zloty lost momentum on Thursday after stronger-than-forecast US inflation data supported expectations that the Fed hadn't yet crossed all the i's and dotted all the t's in its tightening cycle and strengthened the US dollar. Another threat to the zloty is Sunday's general election.

The latest October polls show that only the United Right (Law and Justice - PiS) will cross the 30 per cent vote threshold. In the most up-to-date polls, the average lead over the second-placed liberal Civic Coalition is five percentage points. This outcome will mean that the results of the other three main forces, the Left, the Third Way and the Confederation, will determine who will form the government and whether this will be possible at all. Their latest average support is 10.3, 9.8 and 8.9% respectively. The trends in the polls seem to favour the opposition, but the outcome of the election is on a knife edge.

The United Right's remaining in power without the need to seek a coalition would spawn a positive short-term market reaction associated with the evaporation of pre-election uncertainty. Such a resolution would be to maintain a loose fiscal policy that would complement the National Bank of Poland's monetary policy, which is soft, even compared to other emerging economies. In such a scenario, relations with Brussels should remain rough but probably no worse than they are now. Also, from the point of view of the zloty's medium-term strength, this would be the most neutral outcome, but at the same time, it would go hand in hand with the long-term risk of a gradual erosion of the economy's foundations and difficulties in bringing inflation down to the NBP's target.

In investors' eyes, a deadlock leading to another election, or the need to seek an unstable coalition with the Confederation, would be the worst outcome. Even in that case, the EUR/PLN should not permanently weaken by more than 2% and exceed 4.65. It should also be remembered that spikes, even powerful reactions to surprising voter verdicts, can be very unsustainable. The best example of this is the 2016 US presidential election.

The zloty would react most positively to an opposition victory. The formation of a pro-European government that would prioritise the rapid unlocking of funding for the National Recovery Plan would reduce the political risk bonus. Weakness in the economies of Poland's main trading partners and the gradual solidification of consumption inevitably threaten to shrink the current account surplus. An increased flow of EU funds would not only help the economy to dig itself out of the hole but would also help maintain a favourable balance of payments situation. A rapprochement with Brussels would be undeniable, but a potential presidential veto could hamper an actual breakthrough. High borrowing needs and negative real interest rates will not disappear overnight regardless of the outcome of Sunday's vote, but a gradual drift towards slightly more restrictive fiscal policy can be expected.

In the end of the year, global market sentiment may prove to be more important than the election result. A definitive confirmation of the peak in US bond yields and a final collapse of the three-month-long dollar-strengthening trend would be positive for the entire basket of emerging market currencies, as well as for the mood on stock markets. Conotoxia forecasts that at the end of the year, the euro exchange rate will be in the vicinity of 4.50 PLN.