From Bank of America Merrill Lynch FI Strategist David Hauner
To estimate how much policy rates in EEMEA may have to increase if monetary policy in the US normalizes, we employ six models. The first four are purely empirical: they let the data “speak” and themselves reflect the impact of QE and the output gap on inflation in EEMEA – thus, the estimates are biased downwards in those markets, like Turkey, that benefited most from low global rates for funding the current account deficit. We contrast those with a normative model of neutral real rates that ignores the output gap and indeed any impact of QE, as well as with the interest rate implied by interest rate parity. By using a range of models, we hope to gauge to what extent the currently low level of real rates is explained by QE vs the output gap. The crucial question will be whether reduced capital inflows are disinflationary (through lower growth) or inflationary (through weaker currencies); quite likely they are both, complicating the policy response.
Where Rate Policy is Easiest & Tightest in EEMEA
Note: The median neutral rate is the median of rates obtained from six modelspresented in the report; for Turkey effective TRY funding rate. Source: Haver, Bank of America Merrill Lynch Global Research
Pulling all six models together, Hungary and Poland stand out with the tightest policy, while Turkey and South Africa seems to be the most accommodative. The front page chart shows how much the median neutral real policy rate implied by our six models deviates from the actual real policy rate. By this admittedly crude measure, the policy rate is too high by about 85bp in Hungary and 50bp in Poland, while it is about appropriate in the Czech Republic and Israel. Russia is a tricky case as inflation is likely to drop 200bp by year-end, in our view, implying that the real policy rate would be about 120bp too high by then though it looks 80bp too low now. In contrast, the real policy rate is below the “neutral” rate by about 60bp in South Africa and 90bp in Turkey.
Our results show Hungary, Poland and Russia offer the best remaining opportunities for lower rates in EEMEA, while caution is due in South Africa and Turkey.