In March, CPI inflation rose to 10.9% year-on-year, from 8.5% year-on-year in February. An increase in annual inflation by 2.4 percentage points against the previous month stemmed mainly from the sharp growth of gasoline prices (up 33.5% year-on-year, compared to 11.1% year-on-year in February). The annual growth of food and non-alcoholic beverage prices also gained momentum, contributing another 0.4 percentage points. The remainder could be attributed to higher core inflation that went up 7% year on year. In perspective, money pumping can only be seen as a “fighting fire with fire” scenario.

Many blame inflation on cost-push factors or even speculation, but ultimately all those are consequences, not causes. Oil and gas have risen equally everywhere, yet Consumer Price Index (CPI) inflation is vastly different in the euro area and the United States compared to countries where energy imports are much higher, like Japan and Korea. Why is CPI inflation twice as high in the euro area and the US relative to those Asian countries? Much higher broad money growth in 2020–21. Speculation? Traders do not create prices; they trade on them. Furthermore, traders cannot influence the marginal price of a commodity for long if the fundamentals, inflation, and money reality are not there.

Rising prices are always caused by more units of currency being directed to scarce or tangible assets. Between 2020 and 2021, the assets of the major central banks rose by more than $10 trillion. Furthermore, broad money supply (M3) growth rose at a double-digit rate in 2020 and 2021 in the major economies. Few prices may rise independently due to particular events. War can cause that, but not a generalized and widespread increase in all prices. Furthermore, commodity and food prices were already rising to multiyear highs even before the Ukraine invasion was a rumor. The conflict has just created another excuse to blame inflation on oil and natural gas. Oil and gas will be used as an excuse for inflation as long as low interest rates and massive currency creation remain. When both deflate somehow, the problem of currency debasement will remain. Currency destruction is at the heart of generalized price rises everywhere.

ING Bank expects continued price pressure in services (hotels, restaurants, recreation, and culture). While on the one hand this reflects the post-pandemic recovery of demand, on the other it is linked to the mounting costs of energy and labor (signs of a price-wage spiral).

The scourge of a creeping higher price level is caused by an increase in the money supply, and there are only two ways in which the money supply can increase.

1. The Central Bank creates more “base money” when it buys an asset, usually a government bond, by creating a new deposit out of thin air for the Treasury Department. In economic science, this is called “monetizing the debt”.
2. Second, banks can increase M1, cash, and checking account balances held by the public, via their privilege of engaging in fractional reserve lending. Banks do not have to maintain “base money”, cash, or a checking account balance that can be converted to cash, for each currency of deposit. They need to keep only a fraction of “base money” for this purpose. Therefore, a bank with excess reserves can create a new checking deposit when it lends to its borrowers.

The Polish economy is absorbing new shocks and inflation will continue running at a double-digit pace in the coming quarters for several reasons.

1. Geopolitical tensions will keep gasoline prices elevated despite a high reference base from 2021 and a VAT cut.
2. Already high upward price pressure on energy commodities has intensified as Russia is an important supplier of many of them. It will generate higher costs for transport and various sectors of manufacturing.
3. Further increases in food prices amid lower harvests in the region of the conflict, as well as more expensive gasoline and energy, and fertilizers.
4. Fiscal expansion is ahead. Anti-inflation shield measures should be rather selective in nature, whereas in practice they are broad-based.

After cuts in indirect taxes (VAT, excise duty), authorities are planning a further reduction in direct taxes (the personal income tax rate is to be slashed to 12% from the current 17%). It will be accompanied by higher fiscal spending on defense and refugees (education, healthcare, social protection). The government has also declared aid for farmers suffering from higher prices of fertilizers, and domestic businesses are suffering from an embargo on Russian coal. Analysts worry that the external supply shock is meeting strong domestic demand and the fiscal side would make consumption quite resilient despite inflation.

What does this mean for interest rates? There will be a limited demand barrier for high prices which facilitates second-round effects, i.e passing higher costs onto retail prices. That would make combating inflation a serious challenge. The current policy mix may prove ineffective in curbing inflation and it is likely to become persistent. Monetary tightening will be accompanied by pro-inflationary fiscal policy. A sizable portion of the current surge in commodity and wholesale prices will feed into consumer prices in the coming months and quarters.

Fighting fire with fire, or fighting inflation with inflation; is what happens when all of history and economic reality is wilfully ignored by the powers that be. Money continues to be plentiful, and so too is the government’s desire to spend that which it does not have. Normally, it’s understood that every action has a consequence. This may be true, but unfortunately, those writing the checks, levying new taxation, or borrowing newly created money appear to be immune from any adverse consequences.

In such an environment further monetary tightening will be required and the main policy rate is expected to go up to about 6.5% this year, and the terminal rate to 7.5%. Warsaw is facing a more expansionary fiscal and restrictive monetary policy, which explains why the National Bank of Poland focuses more on inflation and less on GDP than before. The target interest rate will be higher than the previously expected 4.5%, and increases may also take place in 2023.