Aurelia Butler

Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.This week, the world is confronting the horrific human cost of conflict. But as more hellish headlines emerge from the Middle East and Ukraine, economists are also trying to tally the financial cost of this geopolitical fracture.Take the IMF. As its annual meeting gets under way, it has just released its latest World Economic Outlook, with the usual analysis of future trajectories for debt, growth and inflation. One novel feature of this year’s WEO is that the word “fragmentation” is cited no less than 172 times; five years ago it was mentioned just once.No surprise there, perhaps. IMF economists (like global investors) fear that rising strife will undermine growth, not least by shattering global supply chains. “The splintering of countries into blocs that trade exclusively with one another . . . could reduce annual global GDP by up to 7 per cent,” it notes. Indeed, in a striking reflection of this slide towards a cold war-style mentality, the IMF’s models of the costs of splintering alliances are based on the voting blocs that emerged in the UN after Russia’s invasion of Ukraine — a world in which China and Russia are allied against the west.Companies are nervous too: an IMF text-mining exercise shows that “prior to the Covid-19 pandemic, firms barely mentioned keywords related to fragmentation, but usage surged after Russia’s invasion of Ukraine”. This increase is particularly stark in the commodities sector. One intriguing question the WEO raises is how far this bellicose chatter has actually altered western supply chains? Is geopolitical wrangling, in other words, leading to “reshoring” and “friend-shoring”, or not? It is a difficult query to answer accurately, since supply chains are notoriously opaque. Most previous analysis on this issue has relied on cross-border trade and foreign direct investment statistics. These reveal some realignment; US FDI into China has tumbled from a peak of $20.9bn in 2008 to an 18-year low of $8.2bn in 2022. But since the EU retains a record-high trade deficit with China — and the US deficit also hit a record this year — this macro-level data does not really explain what is happening with micro-level supply chains.So, in a bid to contribute to this debate, the Bank for International Settlements has just conducted a novel bottom-up exercise. This uses a vast global data base of companies’ financial accounts “and their declared customer and supplier relationships” to create two snapshots of activity, in December 2021 and September 2023. The results deserve wide attention.This exercise starts by noting that global value chains “are in the midst of a far-reaching realignment” since the Russian invasion of Ukraine and ensuing debates on nearshoring and friend-shoring have “focused attention on the merits of building shorter, more resilient supplier relationships”. The analysis then suggests that global companies’ dependence on cross-border suppliers did fall “markedly” between 2021 and 2023: most strikingly, western companies have reduced one-step sourcing from China. But that does not mean the creation of western-only regional trade networks. Instead, end users are sourcing basic and intermediate goods from places such as China via intermediaries in countries like Vietnam. The result is a stark “increase in the indirect cross-country links, as new firm nodes interpose themselves into existing supply chains”, the BIS says. For Asian-based end users, this is producing a fairly cohesive trade network, since Asian regional integration has risen. For American and European end users, however, it means that supply chains have become increasingly complex. What is emerging is not so much reshoring as reshuffling — a rising level of complexity that has expanded the “distance” in supply chains (layers between raw materials and end users). This has three key implications. First, it means that western companies remain exposed to the vagaries of geopolitics; as a penetrating report from the Centre for Economic Policy Research shows, if China stops selling basic materials to intermediaries, end users would suffer.Second, this creates oversight challenges for western corporate boards and investors since it is harder for companies to track what suppliers are doing (say, on environmental or social issues) if there are multiple stages in a supply chain.Third, this trend, as CEPR notes, is inflationary. Western companies previously created one-step US-China trading links to increase efficiencies and cut costs — this was one raison d’être for globalisation. If supply chains are now becoming more multi-layered, costs will rise; “slowbalisation” is replacing globalisation, as Morgan Stanley says.The key point, then, is that it is not just the spectre of a cold war ban on trade between geopolitical blocs that should worry investors and the IMF — a more subtle lengthening of supply chains will raise inflation and possibly curb growth too. Western customers might well view that a fair price to pay for better national security and corporate resilience. Fair enough. But if the trend continues, it will create a markedly different world from recent decades. Reshuffling — not just reshoring — is the issue to watch now.  [email protected] More

Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.Some European Central Bank policymakers criticised its decision to raise interest rates last month, warning that it risked repeating a 2011 mistake when it raised borrowing costs only to cut them months later after a sovereign debt crisis hit.The objections from the more “dovish” ECB governing council members were not enough to dissuade a “solid majority” from agreeing to raise rates for a 10th consecutive time, according to the official account of the meeting published on Thursday.But the decision to increase its benchmark deposit rate by a quarter point to a record high of 4 per cent was “a close call”, with most ECB council members concluding that “the risks of tightening too much and the risks of tightening too little had become more balanced”.The September decision was the closest call that rate-setters have faced since they began raising borrowing costs during the summer of 2022. “The point was made that the risks of hiking at the present time, and later having to reverse course should the economy weaken by more than expected, were larger than those of introducing a pause in the tightening cycle and having to increase rates at one of the coming meetings,” the ECB said in the minutes. The account of the meeting confirms the widely held view that the ECB is unlikely to raise rates further, barring another inflationary shock that delays the expected slowdown in price growth to the central bank’s 2 per cent target in the next couple of years.Even some of the more “hawkish” ECB council members think borrowing costs are now high enough. Joachim Nagel, head of Germany’s central bank, said this week that inflation was “going in the right direction”, adding that “pausing could be one of the options” when the council meets in Athens on October 26. At last month’s meeting, a majority of council members argued that a further rate increase would “signal a strong determination” to bring price growth down, especially as inflation remained above 5 per cent, even excluding more volatile energy and food prices.“Erring on the side of pausing the first time the decision was a close call could risk being interpreted as a weakening of the ECB’s determination, especially at a time when headline and core inflation were above 5 per cent,” the accounts said.The ECB last month raised its inflation forecast for this year and next, predicting it would only hit 2 per cent in late 2025. Since then, eurozone inflation has fallen faster than expected from 5.2 per cent in August to almost a two-year low of 4.3 per cent in September.A key concern for the ECB is the risk that high wage growth keeps prices rising rapidly, underlined by this week’s demand for a 10.5 per cent pay rise for 2.5mn regional public sector workers in Germany by the Verdi union. Despite “tentative signs” that wage growth had peaked, some council members said last month they wanted “further evidence” it was slowing down. Others pointed out that “supply shocks could push inflation further above the target for longer, which could feed into inflation expectations”. More

Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.Britain’s energy regulator is considering increasing household bills to help suppliers offset record levels of customer debts as household budgets are squeezed by the cost of living crisis. Ofgem said on Thursday it was looking at adjusting the domestic price cap, which governs the amount paid for gas and electricity, after consumer debt to suppliers hit its “highest ever” level of £2.6bn. Ofgem, which warned that debt levels were expected to rise further, is keen to avoid a repeat of the market rout in late 2021 and 2022 when soaring wholesale gas prices triggered the collapse of 30 suppliers, which ultimately added £82 to each household’s bill to cover the cost of bailing them out.It said consumer debts had climbed due to a combination of “the rise in wholesale energy prices, and wider cost of living pressures”.The regulator said it was now considering increasing the amount suppliers could claw back through an existing mechanism that allows them to recoup the costs of recovery of outstanding payments and bad debts through household bills.Ofgem said any one-off adjustment could add about £17 to an average annual household bill but consumer groups warned any such move could prove counterproductive given the already high cost of energy that has helped push up debt levels in the first place. “An increase in the price cap to pay for higher debts will make people’s bills even more unaffordable. Any change must be in the best interest of all consumers,” said Clare Moriarty, chief executive of consumer group Citizens Advice.Households have been grappling with a surge in energy bills following the jump in wholesale gas prices. The price cap, which governs British energy bills, climbed from £1,216 in October 2021 to £4,059 in January 2023. The government stepped in to limit annual bills to an average £2,500, by subsidising suppliers. However, blanket support has now finished and bills are still far higher than long-term averages: the price cap for the October to December period is £1,923. The level of debt facing suppliers has been compounded by a moratorium on the forced installation of pre-payment meters. Ofgem said the ban had increased suppliers’ debt-related costs by about £25mn per month between February and June, with “further significant costs” expected this year. Tim Jarvis, director-general for markets at Ofgem, said any increase in the price cap was “not one we take lightly” but “we must look at all the regulatory options available to us”.He added: “Ofgem cannot subsidise energy or force businesses to sell it at a loss and suppliers must be in a position to offer high-quality services to customers.”Ofgem has opened a consultation on the adjustment to the price cap. If enacted, the increase would take effect in April 2024. More

Futures contracts that settle to the Fed policy rate now reflect about a 40% probability of a rate hike in December, compared with about a 28% chance seen before the report, which showed that the consumer price index rose 3.7% from a year ago. Analysts had expected a 3.6% rise. Another quarter-point interest-rate hike would bring the Fed policy rate to a range of 5.5%-5.75%. Traders now see interest rates ending next year about a percentage point lower, at 4.6%. Before the report the futures contracts pointed to a year-end rate of 4.5%. The Federal Open Market Committee targets 2% inflation.”Overall, there is probably not enough in the report alone to suggest to the FOMC that it needs to be tightening policy again in November, but it will see it as justifying its message that policy needs to remain ‘tighter for longer,’ with the prospect of another rate rise still being kept on the table,” said Stuart Cole, chief macro economist at Equiti Capital. More

These predictions come in the wake of ongoing efforts by Federal Reserve policymakers to curb inflation and slow economic growth through interest rate hikes. Since March 2022, the Fed has been steadily increasing borrowing costs, which now stand between 5.25 and 5.5 percent. Policymakers are currently contemplating whether an additional quarter-point rate increase is necessary before maintaining policy stability.Despite these measures, some investors remain skeptical about another rate hike, particularly in light of recent market rate movements. Fed Governor Christopher J. Waller suggests that financial markets might take on some of the burden of controlling inflation.Even as economists predict a slowdown in inflation, several major corporations continue to raise their prices. Walt Disney Company (NYSE:DIS) and PepsiCo (NASDAQ:PEP) have confirmed their plans to increase prices, with PepsiCo’s finance chief Hugh Johnston confirming this decision. Chipotle (NYSE:CMG) also intends to implement a modest price increase, according to Laurie Schalow, the company’s chief corporate affairs officer. Despite higher prices, Carnival (NYSE:CCL) cruise line reports robust booking volumes.The Fed prefers using the Personal Consumption Expenditures index for measuring inflation, a point emphasized by Michael Feroli, Chief U.S. economist at J.P. Morgan. This potential slowdown in inflation would be a welcome development for Federal Reserve policymakers who have been grappling with high inflation rates for over a year.This article was generated with the support of AI and reviewed by an editor. For more information see our T&C. More

MARRAKECH/FRANKFURT (Reuters) -European Central Bank policymakers expressed cautious optimism on Thursday that inflation was on its way back to 2% even without more rate hikes and raised pressure on governments to maintain the sort of fiscal discipline needed for a soft landing of the economy.The ECB raised its key interest rate to a record high of 4.0% last month but signalled that its 10th hike in a 14-month-long effort to bring down inflation may be its last, at least for now, as the economy was slowing and could even dip into recession. Joining an already long list of policymakers suggesting steady rates for now, French central bank chief Francois Villeroy de Galhau and his Greek counterpart, Yannis Stournaras both planed down the need for further tightening, arguing that policy was already in a setting that could lower inflation.Those comments came just as the accounts of the ECB’s last meeting, published on Thursday, showed that even the last hike was a close call, with tactical considerations tipping the scale towards the increase.”Erring on the side of pausing the first time the decision was a close call could risk being interpreted as a weakening of the ECB’s determination, especially at a time when headline and core inflation were above 5%,” the ECB said.While a solid majority backed the increase, there was also a shift in the perception of risk with policymakers seeing risks to inflation more balanced and they also saw a greater balance between the cost of tightening too much and too little.The ECB’s models also suggested, according to the accounts, that a deposit rate in the region of 3.75% to 4.00% could bring inflation back to 2%, provided the ECB held this level long enough. ITALYWith rates already at a record high and inflation on the way down, policymakers appeared to shift their focus to growth, the potential for a recession and fiscal issues.”If we can follow a monetary path which ensures a soft landing… it’s a much better route for our fellow citizens,” Villeroy told a conference in Marrakech.Stournaras meanwhile noted that borrowing costs had already risen since the ECB’s last policy meeting as a result of higher bond yields, so he questioned if even more tightening was needed, whether via fewer bond purchases or higher charges on banks.These higher borrowing costs are a particular risk for Italy as investors see the country as especially vulnerable, given its high budget deficit, high debt and lack of fiscal discipline.Stournaras played down worries about Italy but also made the case against the ECB ending early reinvestments in its 1.7 trillion euro ($1.80 trillion) Pandemic Emergency Purchase Programme, its first line of defence against a sharp rise in borrowing costs.”The situation in Italy does not raise any particular worries at the moment,” Stournaras added.Long-term bond yields have risen significantly since the ECB’s last meeting as investors prepared for an era of still large budget deficits and reduced or no buying from central banks – a possible headache for big borrowers like Italy.Borrowing costs have eased slightly this week on the back of Federal Reserve officials talking down the need for further U.S. interest rate increases and nervousness about the Israel-Hamas conflict spreading more widely in the Middle East. [GVD/EUR]”This movement of spreads is in a way a reminder to governments that coordination between fiscal and monetary policy is necessary,” Slovenian central bank chief Bostjan Vasle said.”Fiscal discipline is needed to protect spreads,” Vasle said, referring to the premium countries have to pay to borrow.($1 = 0.9446 euros) More