Aurelia Butler

The ECB raised rates by a half a percentage point on Thursday and promised a similar move for March but markets still pared rate hike expectations, taking its lack of guidance for subsequent steps as a wavering in its commitment. Wunsch said markets got the wrong end of the stick because Thursday was a “hawkish decision” and the ECB is likely to keep going, hiking in May and possibly thereafter, depending on how inflation develops. “I don’t think we’re going to move from 50 basis points (in March) to zero,” Wunsch told Reuters. “It might be another 50 basis points or we might be moving to 25. I will certainly not exclude another 50 basis points but that’s going to be dependent on the data.”The key determining factor in how high the 2.5% deposit rate will go is the stickiness in core inflation, which has held above 5% in recent months, well above the ECB’s 2% target.”If core remains persistent, if we keep seeing core momentum being close to 5%, for me a terminal rate of 3.5% would be a minimum,” Wunsch said. “But I don’t want to give any number that is not conditional on incoming data.”Markets currently price the terminal rate at 3.35% by July.But even 3.5% may not be enough and the euro zone should look at rate moves by the United States and the UK if the ECB fails to break the momentum in underlying inflation. “Rates are clearly above 4% in the UK and the U.S.; that would also be a reference for me,” Wunsch said. “Why would we stay at 3% if we have more or less similar core numbers? The Bank of England raised rates to 4% on Thursday while the Federal Reserve lifted its own benchmark to a range of 4.5% to 4.75%”I’m not saying we need to go to 4%… but if incoming data continue to show very persistent core, we will have to look at what the U.S. and UK seem to consider as a restrictive enough interest rates to bring inflation back to 2%.”The problem is that labour markets are very tight and real wages have fallen sharply, so plenty of wage catch up is still likely and that is bound to keep core inflation under pressure, Wunsch added. More

One of the central jobs of the IMF is to regularly check up on all its members. They’re called “Article IV consultations” for reasons the link will explain. Today, the Fund published its take on China’s economy. As usual, it is a tortuously-constructed document — designed not to piss off one of the Fund’s biggest and most sensitive shareholders, while still providing some valuable insight into one of the most important pillars of the global economy.(Underscoring the sensitivity, the process for China’s Article IV actually started back in early Novembe. The projections weren’t finalised until mid-December, weren’t presented to the IMF’s executive board until mid-January, and although the forecasts were incorporated into its January World Economic Outlook update, the full report wasn’t released until this morning). The headline is that the IMF now forecasts that growth will rebound from just 2.6 per cent last year to 4.2 per cent this year thanks to the post-Covid reopening. Here’s the Fund’s summary:Following an impressive recovery from the initial impact of the pandemic, China’s growth has slowed significantly in 2022. It remains under pressure as more transmissible variants have led to recurring outbreaks that have dampened mobility, the real estate crisis remains unresolved, and global demand has slowed. Macroeconomic policies have been eased appropriately, but their effectiveness has been diminished by a focus on enterprises and increasingly less effective traditional infrastructure investment rather than support to households. The pandemic and its impacts have also been a setback to economic rebalancing toward private consumption and to reducing greenhouse gas emissions. A slowdown in growth-enhancing reforms against the backdrop of increasing geoeconomic fragmentation pressures stand in the way of a much-needed lift to productivity growth, weighing on China’s medium-term growth potential.As ever though, the interesting bits are elsewhere, such as the details of the forecasts. For example, the growth of overall “social financing” — a broad measure of debt in the Chinese financial system — is slowing, but will climb to 305 per cent in 2023. Elsewhere, the IMF notes that capital outflows have increased (though remain smaller than what was seen back in 2015-16) and the renminbi is under pressure. But the IMF’s main worry still seems to China’s messy real estate market. It flagged the slowness of restructuring the vast tangled web of property developers — bond prices indicate that 38 per cent of them have or will default — and seems unconvinced by Beijing’s insistence that everything is now fine. Here is what China told the IMF:The authorities were of the view that the problems in the real estate sector remained broadly contained and they were taking strong action. They noted that excessive leverage and weak governance of several large real estate firms had strong spillover effects on the broader property market since the second half of 2021, which were exacerbated by other factors such as the impact of COVID. They expected successive rounds of policy support led by local governments, which have a key role in China’s system of regionally differentiated real estate regulation, to have a gradual but cumulative effect on the market, with signs of stabilization already emerging in the third quarter of 2022. The authorities assessed the banking sector to be generally healthy. They emphasized that banking sector exposures to property developers were limited and that mortgage risk was low due to high prudential requirements and the lack of financial leverage. The overall capital level of the banking system is relatively high. They noted that they continuously monitor and pay close attention to the potential impact of pressure on the profitability of real estate enterprises. On leverage, the authorities emphasized that the private sector debt-to-GDP ratio had been on a downtrend in recent quarters, despite temporary increases due to slower growth.And here is what the IMF itself wrote:Despite the broadening policy response, the crisis has continued and the need for large-scale restructuring remains. Demand-side easing measures have had limited traction in boosting sales amid widening financial turmoil among private developers. The new housing completion funding mechanism will partially address the backlog of unfinished housing, but its scope appears small relative to the potential scale of construction needs should demand remain weak (see Box 1), and formalized forbearance policies are likely to limit creditor incentives to pursue restructuring. Adding to local government difficulties, while the scheme is funded by the central government, local governments must still backstop housing completion loans, and several highly-indebted regions also have large stocks of unfinished housing. The real estate crisis and the growth slowdown reinforce vulnerabilities from high debt in the non-financial sector and add to financial sector strains. Balance sheet pressures are rising at financial institutions, particularly at smaller banks and some non-bank lenders as asset quality has deteriorated. Moratoria on inclusive and pandemic-related loans continue to grow and banks are allowed easing in NPL classification rules for loans to sectors affected by the real estate crisis and the pandemic. Developer bond price declines and some households’ efforts to suspend mortgage repayments imply worsening credit quality in many smaller banks and some non-bank financial institutions from their real estate-related exposures, raising financial stability risks given their limited capital buffers and interconnectedness to the broader banking sector. Funding conditions for some smaller banks have tightened notably, despite ample aggregate liquidity in the system, reflecting in part governance concerns, lower profitability, and slow progress in their recapitalization efforts, although profitability pressures and resulting declines in capital adequacy ratios have also emerged in the banking system more broadly.The IMF wants China to set up “more robust mechanisms” to restructure distressed real estate developers, curtail off-balance-sheet borrowing by local governments and state-owned enterprises, and strengthen the banking system to contain the financial stability risks. The tl;dr is that China reopening will naturally boost growth, but there are a lot of gremlins still lurking in the system that could cause problems in 2023. More

The writer is head of emerging markets economics at CitiAre all Chinese economic recoveries, like Tolstoy’s happy families, alike? Many observers these days seem to think so. The recent boom in metals prices, for example, reflects a confidence in the market that this year’s acceleration in China’s growth rate will cast the same benign shadow over the global economy as earlier big recoveries have done. But that may not be the case.The big Chinese economic recoveries of the past decade or so have been characterised by two features above all: they have been stimulus-driven and investment-led. Large amounts of support via credit markets and local government off-balance sheet financing vehicles were all typically focused on supporting activity in infrastructure and real estate. Fiscal and monetary stimulus delivered a surge in investment spending.This kind of pattern was most obviously apparent in the recovery that followed the financial crisis and the one that followed China’s slump of 2015. During those years, other big economies were not doing much in the way of investment themselves because of the post-crisis austerity policies after 2008 and the effects of the eurozone crisis thereafter. And so China’s investment spending played a huge role in shaping global trade and commodities demand. China’s economic performance in 2023 will be different in the sense that this year’s acceleration in growth will overwhelmingly be just the result of the country ending its lockdown approach to managing the spread of Covid. So, the economy will enjoy what is probably best described as a spontaneous recovery (not stimulus-driven) which will see the biggest effects on services and consumption (and not investment).Why will monetary and fiscal policy be playing a more or less neutral role? As far as fiscal policy goes, a big increase in China’s budget deficits is unlikely because one of the reasons for the reopening in the first place is that Beijing has become a bit more anxious about the stock of debt on the public sector balance sheet. It is almost as if the government wants the recovery to fix its balance sheet problem, rather than use its balance sheet to fix the economy’s problem.Equally, further significant monetary stimulus is unlikely, since Chinese interest rates are already considerably lower than those in the US, raising the risk of further capital outflows if monetary policy is loosened much more.Although there will not be as much of a pivot towards looser macroeconomic policy as in the past, there is a different kind of pivot taking place these days: one from ideology towards pragmatism. Beijing is clearly less focused — for the time being — on “common prosperity” or the “disorderly expansion of capital”. Chinese policymakers’ body language towards the private sector is warm these days, although the authorities’ attitude towards the property sector is still characterised by the slogan “houses are for living in, not for speculating on”.So, hopes for a stimulus-driven, investment-led recovery are likely to be disappointed. More Chinese households going to restaurants and theme parks will have a lot less impact on other countries than more Chinese high-speed trains or apartment buildings would.To put it more technically, the “marginal propensity to import” — the amount of each renminbi of spending that boosts other countries’ exports — is likely to be lower for Chinese services and consumer spending than it is for investment spending. That is especially true from other emerging economies.One other feature of China’s reopening this year bears thinking about, namely its consequences for the balance of payments. While the opening of China’s borders obviously benefits the traditional recipients of the country’s tourism largesse, its current account surplus might disappear fast: tourists spent a net $220bn abroad in 2019, and the pent-up demand for foreign travel is likely to be high.Equally high, though, will be the pent-up demand to park capital abroad. The opportunities that Chinese have had to diversify their wealth internationally have been pretty limited during the past three years. In that time, not only has the country’s property market lost its appeal as a reliable store of wealth, but the China-US interest rate differential has also turned sharply negative. All in all, the incentive to get money out will probably be strong, which is likely to inject some volatility into the performance of the renminbi.For sure the world is a lot better off with a Chinese recovery than without one. But it is best not to assume that this one will be just like those that have gone before. More

The US labour market is expected to have lost further momentum in the first month of the year, as higher borrowing costs from the Federal Reserve damped demand for new hires.Employers in the world’s largest economy are set to have added 190,000 jobs in January, according to a consensus forecast compiled by Bloomberg, a step down from a 223,000 increase in December. While still a solid pace, a figure in line with estimates would mark the sixth-straight month of slower growth. The unemployment rate is forecast to have steadied just above its pre-pandemic low, at 3.6 per cent. Average hourly earnings are expected to have edged up another 0.3 per cent since December, which would translate to a 4.3 per cent annual pace.The data, due to be released by the Bureau of Labor Statistics at 8.30am Eastern Time on Friday, comes as the Federal Reserve debates how much more it needs to tighten monetary policy in order to bring inflation back down to its longstanding 2 per cent target.The US central bank this week switched back to a more orthodox pace of interest rate increases after a string of big moves last year, lifting the federal funds rate by a quarter of a percentage point to a new target range of 4.50 per cent to 4.75 per cent.Speaking on Wednesday, Fed chair Jay Powell struck a more optimistic tone about the economic outlook and the central bank’s handle on what has been one of the worst inflation shocks in decades. That ignited speculation the Fed is closer to ending its rate-rising campaign earlier than previously signalled.Despite acknowledging that the “disinflationary process” had begun, Powell cautioned it was still in the “early stages” and that price pressures remained too intense, especially those linked to what he described as an “extremely tight” labour market. Underscoring the strength of the labour market, job openings in December jumped again, bringing the total number of vacancies to 11mn. Unemployment claims also fell last week to their lowest level in nine months. Wage growth has ebbed, however, and companies have begun to cut back on labour costs, both by slashing hours and cutting temporary workers from their payrolls.Powell on Wednesday reiterated that there was still a “path” to bringing inflation under control without a painful economic downturn and excessive job losses, although he did note that a “softening” of the labour market would be necessary. Most economists polled by Bloomberg expect the US to tip into a recession this year and for the unemployment rate to rise to almost 5 per cent. More

Jay Powell struck a note of optimism this week when he explained why he felt able, at last, to slow the pace of rate rises. The removal of high inflation might only be in the “early stages”, the Federal Reserve chair said, but it was “gratifying” that price pressures in the US were noticeably starting to ease. Christine Lagarde on Thursday was far gloomier, as the European Central Bank president set out the reasoning behind her rate-setters’ latest half percentage point increase. Even though headline inflation had begun to fall in the eurozone too, it was still “far too high”, and underlying price pressures remained “alive and kicking”. While both Powell and Andrew Bailey, his counterpart at the Bank of England, signalled US and UK rates were close to their peak, Lagarde raised the near-certain prospect of another half-point rise in March — and hinted strongly that eurozone borrowing costs would need to rise further beyond that. “The ECB statement confirms that the European Central Bank is the most hawkish of the majors at present,” said Krishna Guha, of Evercore ISI, a research firm. The gap between rate-setters, after months of central banks on both sides of the Atlantic imposing bumper rate rises, is partly explained by the ECB’s decision to wait longer before beginning to tighten. Even if March’s rise does go ahead, the ECB’s deposit rate, at 3 per cent — up from the current level of 2.5 per cent, would remain lower than its equivalents in the US and the UK. The BoE’s tenth consecutive rate increase on Thursday took benchmark borrowing costs to 4 per cent, but the central bank dropped its previous guidance that it would continue to act “forcefully” to contain inflation, simply saying it would act again if there was evidence of more persistent price pressures. After Wednesday’s quarter-point increase, the US federal funds rate now hovers between a target range of 4.50 per cent to 4.75 per cent. Powell said in the post-meeting press conference that, while he would be “cautious about declaring victory”, he saw a path to bringing inflation back to target without a “really significant economic decline”. Fed officials’ latest December projections show the policy rate would need to surpass 5 per cent and remain there throughout 2023 to bring inflation down to 2 per cent. When asked if those projections could be upgraded in March, Powell said the central bank would make “data-dependent decisions”. Some took that as a sign officials are no longer so sure rates will need to remain that high for that long.Despite the dour message from Lagarde, market participants took the ECB’s pledge to “evaluate” the path of interest rates in May as a sign that it was preparing for a pause. “In all cases, central bank chiefs are starting to publicly entertain the notion that rates are reaching a peak,” said James Athey, investment director at Abrdn, an asset manager. But, when asked if the ECB meant to send a signal that the rate rise planned for March would be its last for a while, Lagarde was adamant that was not the intended message. “No, no, no, no,” she said, adding that the central bank would adopt “whatever rates are needed . . . to deliver on our 2 per cent inflation target in a timely manner”. It would also keep them in restrictive territory for as long as needed — a clear signal that markets’ expectations of cuts later this year are not shared by rate-setters. Traders were unconvinced by Christine Lagarde’s warnings, interpreting the ECB’s message as a shift to a less hawkish stance © Alex Kraus/BloombergLagarde pointed to several reasons why inflation could prove harder to tame in the eurozone than in the US, even if the risks had become more balanced than previously. One was ongoing fiscal support for consumers and businesses, which in some cases, will not be removed automatically as energy prices fall. “It is now important to start rolling back these measures promptly,” Lagarde said, warning “a stronger monetary response” would otherwise be required. Wage growth, although still a concern for all central banks, is slowing in the US. It is still accelerating in the eurozone as multiyear deals struck with unions are only just coming up for renegotiation. Those new deals could set pay at significantly higher levels, reflecting the sharp rise in food and energy prices workers have had to absorb over the past year. “It is easier said than done, but it is important in those negotiations that there is a forward-looking approach to what inflation will be, and that we will return it to 2 per cent,” Lagarde said. The ECB president also flagged the impact China’s reopening was having on global commodity prices. Unlike in the US, European goods prices continue to rise, with the effects of the pandemic on supply chains still feeding through. “The ECB will not have a strong reason to cut rates significantly in the foreseeable future,” said Holger Schmieding, economist at Berenberg Bank. “European inflation has lagged the dynamics for the US,” said Tiffany Wilding, an economist at Pimco, an asset manager. In the US, in contrast, she added: “The balance of risk to inflation is more balanced. Inflation is moderating and the Fed, in that environment, just doesn’t need to be as restrictive.”Traders were unconvinced by Lagarde’s warnings, interpreting the ECB’s message as a shift to a less hawkish stance. Sandra Horsfield, economist at wealth manager Investec, said many had focused on the ECB’ describing the risks to both growth and inflation as “more balanced”. After a year of supersized rate rises to tackle record-high inflation, the merest hints that price pressures were coming under control in 2023 proved enough to send bonds and stocks soaring. Giles Gale, a strategist at bank NatWest Markets, said: “In this global environment not hawkish is dovish.” More