EME Macro/Strategy: The next decade - the inflation cost of QE

This report discusses the inflation outlook in the short term, and out to the very long term. To do so, first, we step back and reassess how the business cycle could unfold in the coming quarters, and what structural changes we expect to see in the coming years.
We come to the following two broad conclusions for the short term. First, inflation should hit a low point in the coming months and rebound mildly next year. In the Eurozone and the US, average inflation is likely to stay more than 1ppt below the central banks’ targets, which is one of the reasons why we are likely to see further expansions of QE and fiscal spending plans, with the central banks probably absorbing the 2020E and 2021E budget deficits in full in the developed world. The strongest impact of all this QE should continue to be seen in equity prices in the coming eighteen months, in our view, benefiting mostly the US, as well as Hungary and Romania. Our stock market models suggest that Poland may have limited upside, while the outlook is neutral for Turkey and mildly positive for Russia.
We also advance two conclusions for the long term. First, the CE4 and Greece should benefit the most, in terms of potential real GDP growth prospects in the coming decade, from the EU Recovery Fund and, loosely speaking, the EU institutional framework. This means that house price inflation - the second important consequence of protracted QE - runs less of a risk of entering “bubble” territory in these countries, relative to the high risk of overvaluation of real estate prices in the core Eurozone (except Italy). We believe that the odds favour another decade of central banks’ balance sheet expansion, with only short potential spells of monetary tightening attempts. This, in our view, should help to anchor Sovereign bond yields at very low levels, but does not preclude a rise in borrowing costs in some segments of the market, which may be driven by a policy desire/need to channel savings into retail bonds, or the need to reflect the rising bankruptcy risk from excessive protracted leverage.