Aurelia Butler

Eurozone inflation slowed to its lowest level since May in the year to January, as central bank policymakers prepare to impose another sharp rise in borrowing costs on the region’s businesses, households and governments. Eurostat’s flash index on Wednesday showed consumer prices rose at an annual rate of 8.5 per cent in January, decelerating from 9.2 per cent in December. However, core inflation, which excludes changes in food and energy prices and is considered a better measure of underlying inflation, remained unchanged at an all-time high of 5.2 per cent.The headline figure was lower than the 9 per cent forecast by economists polled by Reuters, and well below the record high of 10.6 per cent hit in the year to October. While the fall in the headline rate will be welcomed by policymakers at the European Central Bank, officials are unlikely to be dissuaded from continuing to raise borrowing costs due to the elevated level of core inflation. “The ECB will need to see much more evidence of cooling price pressures before it can seriously contemplate slowing the pace of hikes further,” said Paul Hollingsworth, chief economist at BNP Paribas Markets 360, a research branch of the bank.The ECB is widely anticipated to increase its deposit interest rate to 50 basis points to 2.5 per cent. The rate has risen from minus 0.5 per cent in June as officials seek to combat inflation. Headline inflation is slowing in most advanced countries, including the US and the UK, reflecting the easing of global energy costs. However, measures of underlying inflation remain a concern for policymakers. The US Federal Reserve is set to raise interest rates by 25bp later on today, while the Bank of England is likely to increase its benchmark rate by 50bp. The decline was driven by energy inflation which slowed to 17.2 per cent in January from 25.5 per cent in the previous month and more than halved from a peak of 41.5 per cent in October.However, food inflation accelerated to 14 per cent in January, up from 13.8 per cent in the previous month and marking a new record high since records began in 1997.Services inflation, a bellwether of domestic price pressures, marginally declined to 4.2 per cent in January from 4.4 per cent in the previous month.John Leiper, chief investment officer at Titan Asset Management, said price pressures, particularly in the services sector, “will remain elevated for some time”.January’s inflation rates varied from 21.6 per cent for Latvia to 5.8 per cent for Spain. Germany has not yet released its figures for January. Some economists think the bounceback in inflation expected for Germany due to one-off energy government measures in December might not be accounted for in the eurozone’s flash estimates.Separate data also published by Eurostat on Wednesday showed that the eurozone labour market remained resilient. Unemployment across the bloc was unchanged at 6.6 per cent in December, the lowest since records began in 1995. More

Hong Kong’s economy suffered a 3.5 per cent contraction last year as the city struggled to preserve its status as Asia’s financial hub, but economists forecast a rebound to growth in 2023. The Chinese territory’s economy shrank 4.2 per cent year on year in the fourth quarter of 2022, according to official government data released on Wednesday, marking a fourth consecutive quarter of contraction.The full-year figure for 2022 was worse than government forecasts of a 3.2 per cent decline, while a contraction in the third quarter was revised down to 4.6 per cent, from 4.5 per cent. Economists forecast Hong Kong’s economy to recover to 4 per cent growth in 2023, which would exceed regional rival Singapore, but warned it would take months for the battered economy to reach pre-pandemic output.The city, which was effectively cut off from mainland China and the rest of the world under travel restrictions that lasted nearly three years, only dropped most of its Covid-19 curbs and resumed quarantine-free travel late last year.A government spokesperson blamed disappointing figures on a plunge in exports and weakened domestic demand under the pandemic curbs. Total exports fell 8.6 per cent last year from 2021, to HK$4.5tn (US$570bn).“An expected strong rebound of inbound tourism following the removal of quarantine arrangements for visitors and resumption of normal travel between Hong Kong and the mainland should underpin a recovery,” the spokesperson said while noting that “softer growth of advanced economies will continue to pose challenges”.

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Hong Kong has also faced financial pressure from falling property prices, which declined about 15 per cent last year. As home prices slid and interest rates rose, the number of negative equity mortgages in the city hit an 18-year high, jumping to 12,164 cases by the end of December from 533 in September.Moody’s Analytics forecast Hong Kong’s 2023 gross domestic product growth at 4 per cent, which would surpass Singapore’s 2.1 per cent. The city-state, which reopened to the world months earlier, recorded growth of 3.8 per cent for 2022.But Heron Lim, a Moody’s Analytics economist, said the “economic damage for Hong Kong will take time to heal”.“We currently project that Hong Kong will only exceed pre-pandemic output peaks in 2024,” he said.Natixis senior economist Gary Ng said Hong Kong could gain up to $22bn in annual tourism revenue, equivalent to 5.9 per cent of its economy, if travel was normalised with mainland China. Hong Kong recorded just 443,000 visitors in the first 11 months of 2022, less than 1 per cent of the same period in 2019. The recovery has also been gradual: just 163,000 travellers visited the city during the lunar new year holiday last week — traditionally a peak for mainland tourists — trailing far behind neighbouring gambling hub Macau with 451,000.

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But some local business representatives expressed optimism about the territory’s outlook.“The return of mainland Chinese tourists has brought a glimpse of hope to the tourism and retail sectors, which play a vital role in Hong Kong’s recovery,” said Jonathan Choi, chair of Hong Kong’s Chinese General Chamber of Commerce. China’s economy expanded 3 per cent last year, its second-weakest growth rate since 1976, but the IMF this week raised the country’s 2023 growth forecast to 5.2 per cent as the economy reopens. More

WASHINGTON (Reuters) – President Joe Biden and Republican House Speaker Kevin McCarthy are set to discuss the nation’s $31.4 trillion debt ceiling on Wednesday, a meeting that will give a first sign of how the two will work together, or fail to, in a divided Washington.The Oval Office talks come as Biden, a Democrat, and the Republicans, who won control of the U.S. House of Representatives in November’s elections, are locked in a standoff over raising the federal government’s borrowing cap. Failure to reach a deal by June could lead to a default that would shake the global economy.Neither side is expecting a solution to emerge from just one meeting, and observers say the talks are most likely to serve as the opening bell for months of back-and-forth maneuvering.House Republicans want to use the debt ceiling as leverage to exact cuts in spending by the federal government, though they have not united around any specific plan to do so. The White House contends that it will not negotiate over the increase, which is necessary to cover costs of spending programs and tax cuts previously approved by Congress.The 80-year-old president, who served as vice president during a similar 2011 showdown that led to a historic downgrade of the federal government’s credit rating, enters the talks with what some of his aides think is a strong hand, including a narrow Senate majority, a party that is unified on this issue, and a strong message for voters.McCarthy, 58, leads a fractious House Republican caucus with a narrow 222-212 majority that has given a small group of hardline conservatives outsized influence.Biden is expected on Wednesday to call for McCarthy to release a specific budget plan and to commit to supporting the nation’s debt obligations, according to a White House memo seen by Reuters.Biden has long-established relationships with both Democrats and Republicans in the Senate, where he served for decades. But he has far less personal history with McCarthy, who joined the Republican leadership on Capitol Hill under former Speaker John Boehner after Biden had already left to become Barack Obama’s vice president.Just one in four Republicans serving in the House today held their seats in 2011, and observers said they may not be fully aware of the risks of courting default, or the difficulties of negotiating in a divided government.Unlike most other developed countries, the United States puts a hard limit on how much it can borrow, and Congress must periodically raise that cap because the U.S. government spends more than it takes in.The 2011 crisis was resolved with a bipartisan deal that cut spending and raised the debt limit but left Obama administration officials smarting. Many felt that they had given up too much in negotiations and had still caused harm to the economy by letting talks persist.McCarthy has less room to maneuver than his Republican counterpart in 2011 did. To win the speaker’s gavel, he agreed to let any single member to call for a vote to unseat him, which could lead to his ouster if he seeks to work with Democrats. He also placed three hardline conservatives on the Rules Committee, which would allow them to block any compromise from even coming up for a vote.Biden seemed to question McCarthy’s ability to keep Republicans in line Tuesday at a fundraiser in New York, calling McCarthy “a decent man, I think,” but noting the concessions he made to become speaker.McCarthy, for his part, said Biden needed to be willing to make concessions to get a debt-ceiling hike though Congress, saying it would be “irresponsible” not to negotiate.The Treasury Department has already started taking “extraordinary measures” to stave off a default until summer after hitting the borrowing limit earlier in January. More

There have been a lot of red faces in the asset management industry lately, with Tiger Global alone incinerating almost $18bn in 2022. But you know who really sucks at investing? Central banks.Take the Federal Reserve, for example. Chair Jay Powell had the Fed gobbling up almost every bond in sight ($4.5tn worth) at the start of the pandemic while rates were already close to all-time lows. There was only one way for yields to go. What was he thinking? Unsurprisingly, the Fed’s portfolio has stunk. The Fed’s last financial update, in September 2022, reveals paper losses of almost $1.3tn during the first three quarters of that year. Since then, 10-year Treasury yields have round-tripped from around 3.5 per cent to 4.25 per cent and back, suggesting the losses may be similar today.And that’s just the Fed’s mark-to-market losses on its portfolio, the SOMA (System Open Market Account). The Fed’s net income — mainly, the difference between what the Fed earns on its bond portfolio, and what it pays out to commercial banks on their reserves at the Fed — has also turned deeply red. The US central bank is now losing around $1bn per week. In 2023 the Fed is likely to turn in its first annual operating loss since 1915.The Fed is not unique, however. All major central banks have haemorrhaged enormous mark-to-market losses over the past year. The Swiss National Bank is sitting on paper losses of $143bn. The Bank of England’s hole is over $200bn. At the Bank of Canada, it’s $26bn. Some estimate the ECB’s loss around $800bn. Most are also operating at a loss. And as the governor of the Dutch National Bank spelt out in a letter to his Ministry of Finance, losses are especially acute where credit quality is high:“All central banks implementing purchase programmes, both in the euro area and beyond, are facing these negative consequences . . . Losses are greater for national central banks that have purchased bonds from governments that enjoy relatively high credit ratings . . . After all, government bonds from these countries carry the lowest interest rates and are therefore more likely to be loss-making when financing costs rise.”In normal times, most central banks remit their profits to their finance ministries. Amid losses, many have now stopped paying those dividends. Daniel Gros from the Center for European Policy Studies therefore argues that it is now clear that QE was “a colossal mistake” that “carried serious fiscal risks, which are now being realised as interest rates rise”. Is that true though?Those fiscal risks are two-fold. First is the balance sheet risk: the bonds that central banks hold have plunged in value. The second is an income statement problem: central banks are sustaining operating losses. In both cases it’s reasonable to wonder about the risks these losses portend for the taxpayer.But, upon closer inspection, it looks like . . . none of it matters?Take the balance sheet issue. As the Fed itself points out, since the securities in the SOMA are held to maturity, it doesn’t matter if they are underwater when marked-to-market:“ . . . as interest rates rise during a period of normalization of the stance of monetary policy, the market value of the portfolio is likely to fall, and it is possible that this could result in unrealized losses on the SOMA portfolio. Nevertheless, even if these unrealized losses are large, they will only affect income if and when assets are sold from the portfolio.”The Fed reports mark-to-market losses for the sake of transparency, but in practice employs amortised cost accounting (not the GAAP accounting that corporations use). The Fed books bond prices at the level they were bought, plus or minus their pull-to-par — typically very small for the investment-grade bonds that the SOMA is stuffed with. The Fed is only very rarely a seller of bonds before maturity; it doesn’t face margin calls and it shrinks its balance sheet by letting securities mature, not by selling them. Those huge mark-to-market losses? They’re never actually realised.But what about that massive (fiscal) sucking sound from the Fed’s negative net income? As the boffins at Brookings have written, there are three reasons recent Fed losses are not a net burden on the taxpayer (FTAV’s emphasis below):“First, even if QE leads to Fed losses in some periods, it will likely also boost Fed profits in other periods. Thus, the losses in a given year may simply offset a portion of the profits in other years, leaving the overall effect on Fed income positive.Second, the Fed does QE to put downward pressure on longer-term interest rates. Thus, if the policy is effective, QE will reduce the interest that the Treasury pays on its long-term debt. So even if the Fed has losses over time on its holdings, there may be no net loss for the Treasury and thus for the taxpayer.Third, the easier financial conditions caused by the QE help boost output and employment — indeed, that is the point of conducting QE when the Fed’s short-term policy rate is constrained by its lower bound. But higher output and employment increase tax revenues and reduce government expenditures on safety net programs. Thus, the net effect of QE on the budget can be positive even if the Fed has losses for a time.”In other words, although it is fun to imagine central banks as big dumb bond funds, they’re not. And it is silly to look at any losses now in isolation from profits they made in other years. The data bears this out., Even when looking only at the profits the Fed remits to the Treasury — and ignoring the broader macroeconomic benefits — the Fed has racked up operating losses of $24bn since August 2022, but earned the Treasury $869bn in the prior decade.It’s obviously not a great look for the Fed to approach Congress cap-in-hand to ask for funding, most of which goes towards paying commercial banks interest on their reserves. The creative accounting also renders this kind of a non-issue. In times like these, when the Fed is sustaining losses, it merely sweeps these into a “deferred asset”, a kind of IOU to the government. From the Financial Accounting Manual for Federal Reserve Banks:If a Reserve Bank’s earnings are not sufficient to provide for the costs of operations, payment of dividends, and maintaining surplus at an amount equal to the Bank’s allocated portion of the aggregate surplus limitation, remittances to the Treasury would be suspended. A deferred asset is recorded in this account, and this debit balance represents the amount of net earnings the Reserve Bank will need to realize before remittances to the Treasury resume.That’s not to say there is no fiscal angle here. Although this IOU doesn’t factor into the calculation of the federal deficit, the government will have to find new revenue to replace the erstwhile remittances from the Fed. But as the Fed income moves into the red, the payments don’t reverse direction: the central bank won’t receive payments from the Treasury, it will cover its operating losses via increases in reserves (AKA “printing money”). The inflationary impact of all this money printing is sterilised, since the “deferred asset” needs to be extinguished by future income. The Fed forecasts that this will happen in 2026.There are two things to note at this stage. First, not all central banks operate this way. In the UK, for example, the BoE’s losses on its Asset Purchase Facility (APF) are indemnified by the Treasury, and payments are a two-way street — the direction of flows depend on whether the APF is operating at a profit or a loss. As of November 2022, the UK Treasury had sent £11bn to the central bank to cover the facility’s losses.Second, there are theoretical scenarios where this creative accounting gets out of hand. Looking at the Fed again, one could imagine losses ballooning and the deferred asset metastasising to such a degree that the Fed has to flood the system with reserves. That could push the central bank into a doom-loop of ever-higher interest payments to depositor banks. This would, at the very least, impinge on its ability to carry out monetary policy. However, for an institution that’s typically levered with gobs of free money ($2trn of currency in circulation and rising), it is an incredibly unlikely danger. As Robert Hall and Ricardo Reis argued back in 2015: “The risks to financial stability are real in theory, but remote in practice.”We conclude that central banks with inappropriate dividend rules may face the risk of reserve explosion, and that this may happen under a variety of scenarios. But we also conclude that the risks of this happening to the Fed and the ECB are remote and that losses can be managed by a temporary buildup of reserves that is reversed well before the next major adverse shock is likely to occur. So, the SOMA’s market value doesn’t matter, since it’s all held to maturity. And, absent a need to remit funds to the Treasury, the Fed’s operating income losses also don’t matter. As an investor, the Fed is essentially a closed-end fund operating with leverage so cheap it would make a hedge fund manager’s weep with envy. These structural advantages mean it is usually highly profitable. But because the Fed also has a wider mission — and a monk’s indifference to profits — it will sometimes suffer huge losses. In the Fed’s own language: While the expansion of the Fed’s balance sheet in response to the pandemic may have increased the risk of the Fed’s net income turning negative temporarily in a rising interest-rate environment, the Fed’s mandate is neither to make profits nor to avoid losses. In other words, the Fed’s mission is to maximise employment and safeguard price stability. If that entails the central bank buying a truckload of bonds right before a generational sell-off — losing a trillion or so in the process — so be it. More

The writer is chief executive and chief investment officer of Richard Bernstein AdvisorsThe Maytag Repairman was a fictional washing machine mechanic who was lonely because no one ever needed to repair a reliable Maytag appliance. Instead of tools, he carried a book of crossword puzzles and cards to play solitaire to combat his boredom.For many years, the US Federal Reserve played the role of the Maytag Repairman with respect to inflation. With the expansion of globalisation and the resulting secular disinflation, there wasn’t much for it to do to fight inflation. Rather, it could generously ease monetary policy during periods of financial market volatility without much concern that its efforts to save investors might spur inflation.The repeated efforts to curtail financial market volatility led to the term the Fed “put”. Investors viewed the Fed’s behaviour as though the central bank were consistently writing a protective put option to limit investors’ downside risk.With perceived guaranteed downside protection, investors rationally took excessive risks because the Fed repeatedly quelled financial market volatility with significantly lower interest rates. Risk-taking often got extreme. There were three significant financial bubbles in the past 25 years — the dotcom boom, the housing market, and the surge in tech companies/growth stocks/cryptocurrencies before recent sharp corrections.Before the pandemic, some investors were puzzled as to why the Fed was concerned with global warming and climate change. Its dual mandate is a focus on unemployment and inflation, yet it began to wade into the politics of climate change.A snide reasoning might be that those at the Fed were bored. Much like the Maytag Repairman who had nothing to do so played solitaire, they were looking for something to do during a long period of secular disinflation. It was easy for the Fed’s attention to wander to topics such as climate change when secular disinflation was making its job relatively boring.However, the Fed’s phone has recently been ringing. Inflation is back and there has been plenty for it to do. Perhaps reflecting the renewed sense of urgency, Fed chair Jay Powell several weeks ago specifically commented that climate change was not the central bank’s responsibility.Unfortunately, some financial observers and Fed officials don’t seem to appreciate the need for focus. Some are advocating pausing rate increases or even lowering rates. Such actions seem terribly premature when the real Fed funds rate has only recently turned positive and inflation remains well above any reasonable target. Investors have been acting as though the central bank is ready, willing and able to supply the easy money protection of the Fed put. The growing notion that inflation has peaked and the central bank will soon “pivot” to lower interest rates has fuelled a rally so far during 2023 in the riskiest, most speculative assets. Meme stocks are up more than 25 per cent, bitcoin is up more than 40 per cent and the Ark Innovation Fund that invests in speculative tech prospects is up more than 30 per cent. The best-performing US sectors year-to-date are communications, consumer discretionary and technology.If the Fed put is a thing of the past, history suggests traditional defensive sectors tend to outperform when there is a combination similar to today’s tighter monetary policy and decelerating corporate profits. Needs outweigh desires and sectors such as consumer staples, healthcare and utilities typically lead. Longer term investors should ignore themes that we have derisively called “cute wiener dogs in the metaverse” to focus on the woeful US underinvestment in real productive assets. Potential returns seem attractive from longer term opportunities in public and private sector infrastructure and manufacturing capacity. Few investors seem aware that analysts’ bottom-up forecasts show the energy sector could grow earnings more than twice as fast as the technology sector over the next five years.It is certainly understandable that financial market observers want the Fed to reverse course and write another put option. Much of the financial sector’s business has been built on generous and cheap money.However, the entire credibility of central banking is on the line and the Fed put should end. No one wants a recession, but allowing inflation to reignite could damage the US economy for a decade or more and, in the current volatile political environment, could even destabilise the governments of the US and other nations. More

Emmanuel Macron’s unpopular plan to raise the retirement age by two years to 64 has ignited a debate in egalitarian-minded France: are the billionaires to blame? As labour unions held a second massive strike on Tuesday, which drew hundreds of thousands of people on to the streets across the country, leftwing politicians have gone on the attack to argue that taxing the super-rich would be a better way to plug deficits in the state-run pension system. In particular, Bernard Arnault, the world’s richest man and owner of French luxury group LVMH, has become a lightning rod with protesters at recent marches carrying signs with his face on a wanted poster and exhorting him to do more for the common good. François Ruffin, a member of parliament for the Somme region and prominent figure in the leftwing Nupes alliance, has been particularly vocal in linking the debate over pensions reform and the way wealth is shared (or not) in French society. “The billionaires have only gotten richer since the Covid-19 pandemic, Macron refuses to tax windfall profits made by our biggest companies, and somehow all the effort to fix the pensions problem must fall on the shoulders of workers?” he said in an interview.“This is a moment to fight for the kind of society we want — not one where capital crushes labour and people are just consumers.” It is easy to dismiss this as typical soak-the-rich talk that often surfaces in France where wealth is viewed with suspicion. But there is more to it.Soon after his 2017 election, Macron was nicknamed “president of the rich” by opponents for his pro-business agenda. His government has cut taxes paid by companies, reduced unemployment benefits and, most controversially, scrapped a wealth tax. Opponents of Macron’s pension reform — which would raise the retirement age from 62 to 64 and accelerate the transition from 41 to 43 years of contributions for a full pension — see it as part of a series of policies that favour the wealthy and businesses over working people. Government officials rebut that by pointing to declining unemployment and strong foreign direct investment figures as proof, the Macron economic agenda has paid off. Plus the government has been generous with aid to blunt the pain first of the pandemic and inflation touched off by the energy crisis, they argue. Nevertheless, the “president of the rich” critique has been ably exploited by far-right leader Marine Le Pen to rack up votes among blue-collar workers, helping her party win an unprecedented 88 seats in the National Assembly in June. Meanwhile, the far-left standard bearer Jean-Luc Mélenchon has used Macron as a foil to argue that capitalism and globalisation are discredited models that must take a back seat to social justice and fighting climate change. Given this political backdrop, the choices Macron made in his retirement proposal may prove risky. To fill the deficits caused by there being fewer workers for every retiree in coming decades, he wants everyone to work longer. It is a burden that weighs more heavily on people who start work at a younger age and those with physically challenging jobs. He also set out red lines: companies would not be asked to pay higher taxes, nor would current retirees, even the wealthier ones, be asked to contribute. The left objected and promptly identified supposed alternatives, while also calling for the retirement age to be brought back down to 60. Oxfam declared that all it would take was a 2 per cent tax on France’s billionaires to plug the €12bn annual pension deficit expected by 2027. One leftist lawmaker tweeted that French start-ups had raised €13.5bn in 2022 so why not look there, while Mélenchon’s party compared the pensions deficit to the €80bn in dividends paid by companies in France’s blue-chip CAC 40 index. These ideas make little economic sense, but they do not have to for them to be good politics. Polls show almost three-quarters of French oppose raising the retirement age.Ruffin, a former journalist who rose to fame by making a muckraking documentary about Bernard Arnault, long ago realised the power of personalising the confrontation between capital and labour. “Bernard Arnault does not have 400,000 times more merit than the workers sewing handbags on his production lines,” he said. Arnault hit back on Thursday as he unveiled LVMH’s record annual profits, arguing that group had hired 15,000 people in France last year and paid €4.5bn in taxes and social charges in its home market.None of that will stop Ruffin. “We have to capitalise on this moment,” he said. More

Donal O’Riain has been struck by the welcome his company received in the US — and it isn’t just the Christmas card sent by the Department of Energy official who is helping it secure federally supported loans. The prospect of abundant government funding thanks to the Inflation Reduction Act is prompting Ecocem, an Irish low-carbon cement producer, to double a planned $120mn investment in California as it reorients spending towards the US instead of Europe, he says.“They are rolling out the carpet for green investment — we were surprised at how personal the contact was,” says O’Riain, Ecocem’s founder and managing director. The “net effect” is that Ecocem, which qualifies for IRA funding on the basis that its cement is produced with carbon emissions that are 40 times lower than average, will “favour further investment in the States [rather] than in the EU”.Cases like that of Ecocem are prompting a brutal reckoning in the EU, as heads of government prepare for a Brussels summit on February 9-10 aimed at figuring out how to respond to the massive subsidies and buy-America provisions being rolled out under the $369bn IRA. “Europe is in panic mode,” says Dutch MEP Paul Tang. At stake are the very fundamentals of the EU’s economic model. Since its inception, the single market has been based on the idea that a level playing field needs to be secured for both the wealthier and poorer nations, and strict limits are therefore needed on state aid that members offer their industries. But even before the US announced its green subsidies, the rules on state aid were already being watered down — in response to the pandemic and the impact of war in Ukraine. France and its allies are pushing to further loosen the shackles on subsidies as part of an active industrial policy aimed at securing key supply lines, embedding the drive towards its climate objectives, and holding its own in the great power competition between the US and China. Mark Rutte, the Dutch prime minister, left, with Emmanuel Macron during the French president’s visit to the Hague this week. Rutte has warned against a race to the bottom on state aid © Peter Dejong/POOL/EPA-EFE/ShutterstockBut economic liberals in countries including Sweden and the Netherlands see a risk that Brussels will, in its rush to compete with the torrent of public cash available in the US and in China, end up “fragmenting” the single market by allowing big member states such as Germany and France even greater latitude to lavish cash on top companies. The IRA is, they fear, fuelling a wider push towards a more interventionist — some say protectionist — mindset in big economies. Mark Rutte, the Dutch prime minister, is among those warning Europe must not “throw the baby [out] with the bathwater” as it attempts to concoct a convincing response to America’s legislation. “The idea of jumping to a sort of race to the bottom on state aid is not to our liking, because one of the most successful things in the European Union since 1957 is the internal market,” he tells the FT. “If we make the wrong decisions it really could have long-term impact — far beyond this IRA thing.”What makes the debate so difficult in Europe is the extent to which America itself has ditched fair-trade norms in its legislation, which provides tax credits and federal support to industries ranging from hydrogen and electric car batteries to solar panels and sustainable aviation fuel. The IRA, which was agreed in a surprise political deal in Washington in August, offers companies billions of dollars, largely through tax credits, to boost investment in new and nascent clean energy technologies. Companies are rewarded for reorganising supply chains to be located either in the US or among allies and partners.

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The EU says the IRA’s local-content requirements are incompatible with World Trade Organization rules that are meant to bar discrimination against products based on their country of origin. It has attempted to convince the US to cut European companies into the benefits, but talks within a US-EU task force on the topic have yielded only partial progress in the area of electric vehicles and batteries. Ecocem is the type of company that Europe desperately wants to keep onshore. The EU is aiming to cut its greenhouse gas emissions by 55 per cent by 2030, compared to 1990 levels, while fighting an energy crisis brought on by dramatic cuts in supplies of gas from Russia.On both fronts, the bloc needs every scrap of renewable energy and clean technology it can get. But it is competing in a global market where both the US and China are pouring hundreds of billions into green industries through state funding.O’Riain says that in France, where Ecocem has two factories, the company received no public subsidies as they were not available at the time. State assistance, he adds, “means we can raise our horizons in terms of how fast we can scale.” The question of state aidThe pressure on the EU single market has been building for some time.Some EU diplomats and politicians argue the union has long been guilty of a naive approach towards its green industry by permitting China, in particular, to dominate critical sectors instead of nurturing Europe-based champions. They cite the rampant growth of photovoltaic solar panel manufacturing in China a decade and a half ago. Brussels imposed anti-dumping duties on Beijing in 2013, alleging Chinese producers were getting unfair subsidies. Ursula von der Leyen, the European Commission president, left, with commissioners Thierry Breton, right, and Margrethe Vestager. Breton wants the EU to pursue strategic autonomy, while Vestager has emphasised keeping an open approach to global trade © John Thys/AFP/Getty ImagesFrance is now leading the charge for a harder-headed approach to international trade and work on securing its own resilience and “sovereignty”. Paris in January demanded a “made in Europe” strategy in response to the IRA, entailing a reinforced European industrial policy and a far-reaching simplification of the EU’s state aid framework, which curbs government subsidies that could distort the single market. Within the commission Thierry Breton, the French commissioner for the EU’s internal market, has championed the push for European “strategic autonomy” in industries from pharmaceuticals and semiconductors to critical raw materials. “It is high time to reconcile climate neutrality policy with industrial competitiveness policy,” he said on Friday during a trip to Washington. Three commissioners from free-market minded countries — Margrethe Vestager of Denmark, Valdis Dombrovskis of Latvia and Frans Timmermans of the Netherlands — are pushing back, writing in the Financial Times last week that the EU should focus on creating a “business-friendly environment” while maintaining its “open approach to global trade”. Vestager, the EU’s competition commissioner, is due to unveil state aid proposals on Wednesday as part of a wider set of policies aiming to streamline permitting for new green projects and easing payments of EU money. She tells the FT that changes needed to be “focused”, arguing it was only in a few sectors that there was an “acute risk” of investment shifting from the EU to the US. “If the state leads this transition then on some occasions state aid is also legitimate, as long as no one then jumps to the conclusion to say ‘well, let the taxpayer do everything,’” she says. “Without private investment, it’s not going to happen.”The prospect of a further loosening in state aid controls has, however, caused deep disquiet this week among some senior competition officials in Brussels, where some fear the floodgates are opening on public subsidies in Europe. They complain these “temporary” relaxations of its state aid rules are becoming a persistent habit. Brussels pushed through a time-limited loosening early in the Covid-19 crisis, but then followed that up last year with further flexibility in response to the Russian invasion of Ukraine and the energy crisis. Constraints will be eased for the semiconductor industry via the proposed European Chips Act. “There is a joke that nothing is more permanent than temporary things,” says one EU official. “This temporariness is starting to last.”The results of these relaxations of subsidy restraints have been hugely imbalanced. EU member states have won approval for €672bn subsidies under the bloc’s temporary crisis framework, of which no less than 53 per cent has been notified by Germany, the EU’s biggest economy, equating to around 9 per cent of its annual gross domestic product.

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France’s share stands at 24 per cent, or just above 6 per cent of GDP, while fiscally stretched Italy sought approval for only around 7 per cent of the total — equalling less than 3 per cent of GDP. Specialists say this contributes to a deeper fragmentation between EU countries and indeed regions. Craig Douglas, the founder of World Fund, a €350mn venture fund based in Berlin, says the discrepancies between the “specific buckets of capital” in Europe available are sharp. “If I want to build a manufacturing facility in Aachen or Bavaria there is more regional capital available than doing it in Paris.”Unlocking the moneyThe debate over state aid is reawakening a related dispute over how to fund subsidies. European countries with strained public finances insist that any loosening of state aid constraints needs to be balanced by the creation of a big new EU-wide pot of cash to help to support member states with limited fiscal resources. Some, including Italy, are pushing for much more flexibility in how they can deploy existing EU funding. Germany, the Netherlands and other fiscally conservative states are, however, fully prepared to block any additional common EU borrowing, meaning any fresh cash on tap is likely to be modest. They argue the bloc already has ample funding available for its green transition, and that it is the US that is playing catch-up with Europe’s existing initiatives. Back in 2020, for example, across the EU some €81bn was forked out to subsidise renewables, according to commission figures. Joe Biden during the signing ceremony in August for the Inflation Reduction Act. Economic liberals fear the act has fuelled a wider push towards a more interventionist mindset in big economies © Mandel Ngan/AFP/Getty ImagesThat has been enhanced by the €800bn NextGenerationEU Covid-19 recovery programme, under which capitals are required to commit at least 37 per cent of spending to the green transition. On top of that, about €100bn of the EU’s 2021-27 cohesion spending, which boosts regional development, is expected to be green.While the IRA’s widely heralded consumer subsidies on US electric vehicles amount to $7,500, figures from the European Automobile Manufacturers’ Association and Bruegel show that the average in the EU is not actually that far behind, at the equivalent of $6,500.Part of the EU response to be discussed at next week’s summit will be making it easier to redirect pots of EU money to specifically respond to the IRA. Some EU companies fear Brussels is going to be too cautious in its response. Ilham Kadri, chief executive of Solvay, the Belgian chemicals company, says her company is already benefiting from funds from the Inflation Reduction Act, plus the state of Georgia has also committed to $27mn of state and local tax incentives.Her experience of getting subsidies in France, by contrast, was a “long, tough journey”, she says, with a lot of bureaucracy “for almost, I would say, nothing”. Europe, she says, needs to “wake up” and address not only state aid limits but also lengthy regulatory processes. Kadri’s experience illustrates a problem many executives complain of in the EU regime: the sheer complexity of applying for the pots of cash scattered between different EU, national and regional programmes. The IRA distributes support via simple-to-obtain tax credits, which are something Brussels has no power to hand out given tax is a national competence. Vaitea Cowan, co-founder of Enapter, which has patented technology to produce green hydrogen, says she would need four people full time on her team just to understand what the EU had to offer in terms of funding and how they could access support. “The support schemes just for renewable hydrogen are extremely hard to navigate,” she says, ranging from the European Investment Bank to the Horizon science programme. “There are so many of them . . . we need Europe to have much more pragmatism.”

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EU funding also seems to favour industry incumbents rather than innovative start-ups. The first call-up for large-scale projects in 2020 through its Innovation Fund received 311 applications, from which seven grants were awarded — all to projects led by large companies including BASF, a multinational chemical company, and the Italian energy company Enel.Cleantech for Europe, an industry body for green technology start-ups, noted that this represents a 2 per cent success rate for applicants. Projects that had been selected mostly focused on the carbon capture and storage, a technology which sets out to remove carbon produced by fossil fuels, rather than projects that would prevent the emission of carbon dioxide in the first place.Top EU officials readily admit permitting processes for new installations take far too long. Jules Besnainou, Cleantech for Europe’s executive director, warns that there is a risk of “leakage” of clean tech industries out of Europe “no matter what”. The question, he says, is whether the EU response comes in time to scale up these industries, or “do we just lose them?”A broader strategyEurope’s economic liberals argue a lot of the wrangling over public subsidies misses the wider point. Countries such as Sweden, which holds the EU’s rotating presidency, want the EU to focus instead on underlying competitiveness, loosening regulatory constraints and boosting fundamentals such as worker skills, rather than looking for ways of marshalling more public money. Financing reforms might help. Delivering on the EU’s carbon reduction objectives requires additional investment of €520bn a year in 2021-2030, according to the commission, the majority of which will have to come from the private sector. Yet the continent remains heavily reliant on bank-provided finance, while its attempts to forge stronger and more vibrant capital markets are proceeding at a snail’s pace.

Any adjustments to the state aid regime or creation of new EU resources must go “hand in hand” with reforms to the internal market, argues Cecilia Malmström, the EU’s trade commissioner from 2014 to 2019, plus a drive to conclude more trade deals. It would be a “dangerous path” to engage in a tit-for-tat response to the IRA, she says. But the EU’s band of free-market cheerleaders feels embattled, especially following the departure of one of the UK, which had been one of their most vocal members. Plaintive references to WTO norms sound out of touch with the great power competition driving the world economy, embodied by the “decoupling” from China driven first by President Donald Trump and continued by his successor Joe Biden. “Even the more liberal ones in the flock realise the world has changed,” says one senior EU official. When it comes to the IRA, the message from Washington is “just do the same as us, because we are not going to change anything”. Data visualisation by Chris Campbell More

The US Federal Reserve is set to lift its benchmark rate by a quarter of a percentage point on Wednesday, marking a shift to slower, more conventional interest rate rises as inflation falls.The Federal Open Market Committee is expected to raise the federal funds rate to a new target range of between 4.5 per cent and 4.75 per cent, the highest level since September 2007. A quarter-point increase would be a break with the unusually large half and three-quarter-point rate rises the Fed relied on in 2022 as it wrestled with persistent price pressures.The Bank of England and the European Central Bank are due to implement their own interest rate increases on Thursday, with both expected to opt for half-point adjustments.Fed officials have said slower tightening will give them more time to assess the impact of their actions on the economy as well as greater flexibility to adjust course if necessary.The Fed is still expected to signal it will continue its campaign to raise rates, amid lingering concerns it has not fully curbed inflation.The Fed’s statement, due to be released alongside the rate announcement at 2pm Eastern Time on Wednesday, will be closely parsed alongside chair Jay Powell’s press conference, which begins at 2.30pm Eastern Time, for signals on how much more tightening the central bank plans to do.Since the central bank started raising rates last March, its statement has consistently noted that the FOMC expects that “ongoing increases in the target range will be appropriate”. Changes to that wording may be taken by Wall Street that the Fed is closer to the end of its rates-rising campaign than previously thought.Alternatively, the Fed may choose to note that it expects to keep its policy rate at a restrictive level “for some time”, in a bid to emphasise it does not plan to cut rates in the near future.In December, most officials projected the fed funds rate would peak at between 5 per cent and 5.25 per cent this year and for that level to be maintained throughout 2023. Many have continued to push that message ahead of this week’s meeting, even as the Fed’s actions begin to have a more noticeable effect.

Price pressures broadly appear to have peaked, while consumers are spending less and companies have begun to cut costs. However, wage growth remains high and the labour market has not yet softened to the degree officials say is necessary to bring inflation down to the Fed’s 2 per cent target.If the path Fed officials set out in December still holds, it suggests the central bank will implement two more quarter-point rate rises beyond Wednesday’s increase.But policymakers have been unable to convince money managers and traders in fed funds futures markets. Financial markets continue to assume that rates will peak short of 5 per cent and that Fed will subsequently cut them by half a percentage point before the end of the year.In tandem, US mortgage rates have slid from their peaks, stocks have rallied and corporate borrowing costs have fallen. That has set the stage for what Tobias Adrian, the IMF’s head of monetary and capital markets, warned could be a shock if the inflation data disappoints in the future and the Fed tightens further as a result. More