This article is a part of Poland Unpacked. Weekly intelligence for decision-makers
This year, the region’s currencies have posted substantial gains against the world’s key reserve currencies – the euro and the dollar. Among the three economies with their own currencies and floating exchange rates, the Hungarian forint has strengthened the most. It has appreciated by 7% against the euro so far this year, and by as much as 20.6% against the dollar. The Czech koruna has gained 3.5% against the euro and 16.7% against the dollar.
Interactive chart Within this group, the zloty has been the weakest performer. It has risen by a symbolic 1.2% against the euro and by 14% against the dollar. Over a longer horizon, however, the picture looks different. It is the zloty and the koruna that are at their strongest levels against the dollar since 2018, while the forint is at its strongest since 2021.
Interactive chart Drivers of the appreciation
The immediate cause of the region’s currency appreciation has been an inflow of foreign capital into these economies. Much of this has taken the form of so-called portfolio investment – purchases of equities or bonds by investors – rather than direct investment in the real economy. Stock-market performance bears this out. Poland’s WIG20 (top 20 companies on the Warsaw Stock Exchange) has gained more than 40% so far this year; the PX index, tracking the largest companies listed in Prague, is up by almost 50%; and Hungary’s BUX, which groups the country’s blue-chip stocks, has risen by over 38%.
The second direct reason for the region’s currencies strengthening against the dollar has been the weakness of the American currency itself. This reflects the actions of the US president and a deterioration in financial markets’ confidence in bonds issued by the US government.
More important than these immediate drivers, however, are the underlying fundamentals. Three factors stand out. The first is the decline in inflation, even though it peaked at levels well above those in the euro zone. Investors have come to believe that prices are now stable, which reduces investment risk. Moreover, Hungary and Poland maintain positive real interest rates. After adjusting for current inflation, real rates have been around 2%.
Interactive chart The second factor is macroeconomic balance in these economies. Poland, Czechia and Hungary do not run significant current-account deficits. In other words, they are not in a position where they are compelled to borrow heavily from abroad.
The third factor is a decline in geopolitical risk. At the outset of the conflict, the risk of the war in Ukraine “spilling over” into other countries in the region was assessed as high. Today, however, such a scenario is considered highly unlikely.
The benefits and costs of a stronger currency
A strong currency brings both benefits and costs for an economy. Its main advantage is that it helps to curb inflation: imported goods, including raw materials and fuels, become cheaper. Added to this are lower costs of servicing foreign debt. A strong currency is also a signal of investor confidence in a country, which can make it easier to raise debt abroad.
On the other hand, a strong currency undermines price competitiveness. It makes exported goods and services more expensive. It also raises labor costs for foreign investors and can therefore influence decisions on where to locate direct investment.
At present, the benefits outweigh the costs. A strong currency has been one of the key factors behind the stabilization of inflation. Over time, however, this balance may shift.
Key Takeaways
- Currency strength reflects both capital inflows and improved fundamentals. The appreciation of Central European currencies has been driven not only by strong portfolio inflows and a weaker dollar, but also by falling inflation, positive real interest rates, sound external balances and lower geopolitical risk.
- The gains are uneven but historically significant. While the forint has been the strongest performer this year, and the zloty the weakest, both the zloty and the koruna are at their strongest levels against the dollar in several years – underscoring a broader regional re-rating by investors.
- Stronger currencies help tame inflation but threaten competitiveness. For now, currency strength has supported disinflation and reduced debt-servicing costs. Over time, however, higher export prices and rising labor costs may weigh on competitiveness and investment decisions.