Aurelia Butler

The head of Ireland’s central bank has said investors are wrong to bet on eurozone interest rates rising in June, predicting policymakers will be careful to avoid “killing off the recovery”.Gabriel Makhlouf told the Financial Times that “the path to normalisation” of eurozone monetary policy had become clearer, after inflation hit a record high in the bloc while unemployment dropped to an all-time low.The European Central Bank could stop its net bond purchases in June or a few months later, and would only raise rates after that, said Makhlouf, who is a member of the Frankfurt-based bank’s governing council.“The idea that we could hike interest rates in June looks very unrealistic to me,” said Makhlouf. “I certainly think there’s a bit of difference between the calendar we’re working to and the one some market participants may have in mind.”“I’m reasonably confident net asset purchases will end this year,” he added, referring to the ECB’s bond-buying programme, which has hoovered up €4.8tn of assets since it started in 2015. “The question is what is the pace at which my foot sits on the accelerator, and am I talking about June or am I talking about the third quarter.”The Irish central bank governor is widely seen as a moderate between the “hawks” pushing for a rapid end to bond purchases and negative interest rates and the “doves” arguing in favour of continued stimulus. His comments, in an interview with the Financial Times last week, are the latest indication that most ECB rate-setters want to avoid rushing to exit its ultra-loose monetary policy. Christine Lagarde, the bank’s president, last week played down the chances of a “measurable tightening” of policy and said any normalisation would be “gradual”.Investors have priced in a June rate rise by the ECB since Lagarde triggered a sell-off in eurozone bond markets this month by saying inflation risks were “tilted to the upside” and there was “unanimous concern” about rising prices on its governing council.The last time the ECB raised interest rates, in 2011, it was widely seen as a mistake, coming just as the eurozone debt crisis erupted. The increase had to be reversed with a rate cut later that year.The 2011 rate rise was prompted by misplaced fears at the ECB that surging energy prices would have “second-round effects”, the process by which rising costs cause businesses to raise prices and workers to demand higher wages, feeding an inflationary spiral.“There are similarities between where we are today and 2011, but there are also differences and we need to make sure that our assessment is putting the current high headline numbers [of inflation] into a broader context,” said Makhlouf, who was a finance ministry official in the UK and New Zealand before joining Ireland’s central bank in 2019.ECB policymakers need to judge how “durable” the recent price pressures would prove, he said, adding that this was likely to hinge on whether wages start rising faster as workers respond to the rising cost of living.“When I talk to businesses based in Ireland and multinationals, one of the top subjects that comes up every time is the dearth of talent and a tightness of the labour market for talent,” he said. “There is a bit of discussion about wage pressures, but not to the extent that I can say I have now got strong evidence of things moving.”Wages are likely to start rising as labour markets rebound across Europe — Ireland’s unemployment rate fell from 7.7 per cent last March to 5.3 per cent in January — but Makhlouf said: “I certainly want to see fresh evidence.”Record inflation was “impacting on households and businesses in ways they don’t want, and no one wants,” he said, adding: “We also don’t want to kill off the recovery.” More

The name of a small office at the top of a drab skyscraper in the centre of Vilnius has set off a geopolitical firestorm that threatens billions of dollars in trade.This is the Taiwanese Representative Office in Lithuania, a diplomatic outpost so new that the chief of mission’s business cards still carry the address of his previous posting in Latvia.At issue is the fact that the name of the mission explicitly refers to the disputed island of Taiwan — and not, as is more common, its capital city of Taipei. To Eric Huang, who heads up the office, this makes complete sense. “We are representing Taiwan, not the city of Taipei,” he says.But for the Chinese, the opening in Lithuania of what amounts to a de facto embassy represents a big step towards formal recognition of Taiwan, which Beijing claims as part of its territory. And it has retaliated furiously to this perceived provocation, not just by stopping direct imports from the Baltic country but by taking aim at global supply chains — stopping German companies, for instance, from using Lithuanian components in China.

Eric Huang of Taiwan’s foreign affairs ministry and newly appointed director of the representative office, third from right, poses with other staff outside the Taiwan Representative Office in Vilinius, Lithuania © Taiwan Ministry of Foreign Affairs/AP

For many policymakers in Europe, Asia and the US, the tactics that China is deploying in the dispute with Lithuania mark a watershed moment for the global economy. Although China has long used various types of economic coercion in political disputes with countries from Canada to Australia, this represents the first time the Chinese government has tried to prescribe where companies can, or in this case cannot, source parts for goods they make in and sell to China. The precedent being set by China should send shockwaves, say officials in the Baltic country. “It is Lithuania today,” says economy minister Ausrine Armonaite. “It may be any other country tomorrow.” The stakes are particularly high for the EU. It is the first time China has unleashed the full power of its economic coercion toolkit against an EU country, testing the bloc’s ability to prioritise its joint strategic interest over individual countries’ or companies’ short-term gains. Seeing the workings of its single market threatened, the EU has filed a case against China at the World Trade Organization, which the US, Australia, Japan, UK, Canada and Taiwan are all seeking to join.“It is a test for how far China will go with its punishments, how far Taiwan will go in trying to make up for the economic damage, how far the EU will go in standing together, how far the US will go in shielding Lithuania from the fallout,” says Jakub Jakobowski, a senior fellow with the China programme at the Eastern Studies Centre (OSW) in Warsaw.Lithuanian businesses may not wait around to see the results of that test. Kristijonas Vizbaras, a Lithuanian entrepreneur who has co-founded a series of companies, is already examining whether to move manufacturing for his family’s new sensor venture from his home country to Belgium.Technicians work on laser-based devices at Brolis Sensor Technology’s lab in Vilnius. In Lithuania’s laser sector about one in two parts sold end up in China © Brolis“It hit like a bomb. Everybody was completely flat-footed,” says Vizbaras, explaining that in Lithuania’s laser sector about one in two parts sold end up in China eventually. “We fully support Taiwan as a democratic country. But we are extremely angry at our government and how they acted,” he adds. “We have to de-risk and divert our future expansion plans out of Lithuania. This is what we are doing, and what a lot of other businesses are doing.” Behind Lithuania’s decisionLong known as perhaps the most vocal critic of Russia and its increasingly aggressive stance, Lithuania has developed growing sympathy for Taiwan and its efforts to resist being pulled into the orbit of another authoritarian state, China.But officials in Lithuania’s former government, in power in Vilnius until October of 2020, say their initial discussions focused only on a mission named after Taipei. A new government changed tack, unveiling the new name last July even as Lithuania confronted not just the Covid-19 pandemic but a hybrid attack from Belarus forcing migrants over the border as well as Russian sabre-rattling in nearby Ukraine. Taiwanese Representative Office in Vilnius. For the Chinese, the opening of what amounts to a de facto embassy is a big step by Lithuania towards formal recognition of Taiwan © Petras Malukas/AFP/Getty Images“It was a bit surprising. I still don’t know why they did it. We should save our ammunition, and not fight on several fronts at the same time,” says one former senior official. Foreign minister Gabrielius Landsbergis says it was never Lithuania’s intention to cause a diplomatic fuss. “We didn’t pick a fight; a big country decided to teach the world a lesson,” he says.Landsbergis presents the move as part of Lithuania’s values-based foreign policy, which aims to support democracy and freedom around the world. Lithuania, which only regained independence in 1990 after almost half a century of annexation by the Soviet Union, sets stock in standing up to authoritarian states, adding China to a list that includes neighbouring Russia and Belarus as well. “Sometimes those principles and values are not very much liked by our neighbours or some other countries. But we cannot just choose to go another way. It is our way. We understand very well it is not the way that is easiest,” President Gitanas Nauseda told the Financial Times last summer. An EU official scoffs: “They see themselves as leaders of the free world.”But the name change also came after a number of moves had already antagonised Beijing last year, including Lithuania withdrawing from the 17+1 format China used to deal with countries from central and eastern Europe, a ban on using Huawei equipment to build 5G networks, and a parliamentary motion calling China’s actions against Uyghurs in Xinjiang “genocide”.Landsbergis insists that Lithuania did not take the decision in the hope of receiving some form of compensation from the Taiwanese. “We are not selling the name of the representative office,” he says.Gitanas Nauseda, Lithuania’s president, has adopted a values-based foreign policy that has antagonised China © Geert Vanden Wijngaert/BloombergStill, support has come. Taiwan set up a $200mn fund to invest in Lithuania; it is also offering $1bn in loans to joint projects between the two countries. Armonaite says Lithuania is looking to boost investments in semiconductors, IT, and biotech using the funds. The US, in turn, has given Lithuania $600mn in export credits that Vilnius can use to buy technology or goods as well as support its companies, recognition for its action on what is Washington’s main foreign policy goal of containing China. “US support has been steadfast. The US and many other countries clearly see this as a challenge not just for Lithuania or the EU, but for the world,” a state department official says.Turning the screwChina claims Taiwan as part of its territory and threatens to invade if Taipei resists submitting to its control indefinitely. Beijing pressures all third countries, international organisations and companies to treat Taiwan as part of China. As a result, all but 14 countries have cut official diplomatic ties with Taiwan and the country is frozen out of international organisations.China’s retaliation against Lithuania has been far from subtle, even if Beijing has refused to acknowledge it even exists. “The claim of so-called ‘coercion’ against Lithuania is fabricated out of nothing,” a foreign ministry spokesman said last week. Ministry spokesman Zhao Lijian said: “Lithuania should stop confusing right and wrong and maliciously hyping things, let alone trying to gang up with other countries against China.” The Baltic country suddenly disappeared from the list of countries in China’s customs code while multiple companies — from Lithuania, Germany and elsewhere — reported difficulties getting components labelled as made in Lithuania into China.

Australian foreign affairs minister Marise Payne and Lithuania’s counterpart Gabrielius Landsbergis hold a press conference at Parliament House in Canberra, Australia, last week © Lukas Coch/AAP/AP

“Right now, China is blocking all parts. They are looking through all German auto parts and saying ‘this LED strip was glued in Lithuania, send it back’. You can’t do business that is interlinked to global supply chains from Lithuania,” says one Lithuanian-based supplier. The measures fit into a long history of China leveraging its big and growing market to punish foreign countries or companies over political agreements. Partial trade bans have been imposed on Japan, Norway, Australia, and Canada while Beijing has throttled the flow of Chinese tourists to countries it has had acute disputes with. China has even permitted public demonstrations calling for boycotts of Japanese cars and goods. But analysts have noted a sharp increase in Beijing’s use of such punitive measures over the past four years, as well as more signs of European countries and companies being targeted. “The trajectory is really worrying,” says Jonathan Hackenbroich, a policy fellow at the European Council on Foreign Relations in Berlin.

Video: How China uses trade as a weapon

Companies in Lithuania are developing workarounds, according to officials and business executives in Vilnius, including disguising the origin of parts and treating work in Lithuania as a service that does not have to be declared. “The priority is to ensure that the products that end up in China do not contain unique Lithuanian parts, meaning those that are labelled and distinguishable,” says a supply chain expert at an international consultancy with knowledge of German companies’ operations.A far bigger question is how the dispute could change investment and supply chain decisions not just for Lithuania but more broadly multinational companies. “If China succeeds in weaponising European value chains now, it will be encouraged to do this in the future, and it might influence decisions about new investments,” says Jakobowski. People take part in a human chain protest in support of the Hong Kong Way, a recreation of a pro-democracy ‘Baltic Way’ protest against Soviet rule three decades ago, in Vilnius in 2019 © Petras Malukas/AFP/Getty ImagesHe sees China’s new coercion technique as part of a broader policy of getting big foreign companies to locate ever bigger parts of their supply chains in China. “This is part of the bigger decoupling game,” he adds.In Lithuania, there is a hope that companies can readjust and find other partners just as they have when neighbouring Russia has thrown its weight around. Businesses, however, are trying to view it from both sides. “We can’t avoid the world’s second-biggest economy. We moved towards China for the past 30 years and can’t jump away in a day,” says Vidmantas Janulevicius, president of the Lithuanian confederation of industrialists. “But we can’t be dependent on one country. It’s a very good wake-up call for Europe that we need to have diversified supply chains.” The right fight?The EU has tried to respond swiftly, launching the WTO case against Beijing. But it is struggling to balance the need to defend the single market with the reality of business dependence on China.In December, the EU unveiled plans to allow it to take swift retaliation against economic coercion — especially from China and Russia — through 12 possible countermeasures, including levying tariffs and banning chemical imports. France has made adopting the anti-coercion instrument one of the key parts of its current six months leading the council of EU member states. Thierry Breton, the EU internal market commissioner, is set to visit Vilnius in the coming days.“When it was felt that the single market was the target then the attitude [in the EU] changed,” says Landsbergis. He adds that thanks to the WTO case “we are entering a much more stable situation”.A container terminal in the Port of Klaipeda, Lithuania. China has stopped direct imports from the Baltic country and is also targeting global supply chains © Valda Kalnina/EPA-EFEBut not all EU states have appreciated Lithuania’s approach, with some accusing it of acting unilaterally against such a big power just as the continent deals with Russia amassing more than 100,000 troops on its border with Ukraine and in neighbouring Belarus. “I don’t really see what was to be gained by forcing an issue that the Chinese are so sensitive about,” says one official in a EU member state. China is trying to exploit the unease in some EU capitals about Lithuania’s move, says Hackenbroich. “Given that division and the lack of tools to respond on the European side, and the capability and willingness to exploit dependency on the Chinese side, China is in a better position.”Some officials believe that the EU needs to dramatically up its game in responding. “If China now leverages their market to use our companies for sanctions against other countries, we have a big problem,” says an EU diplomat in Asia. “This is something the US does already, so EU companies will be on the receiving end of such secondary measures from the world’s two economic superpowers.”

The US frequently uses economic sanctions that apply extraterritorially. For example, its ban on semiconductor supplies to Huawei that use US equipment bars TSMC of Taiwan, the world’s biggest contract chipmaker, from producing chips for the Chinese technology group because it uses US tools.The EU has a law designed to counter such pressure but it is largely dormant. The so-called Blocking Statute was devised in response to US sanctions against Cuba and Iran, which also apply to non-US companies. Analysts say it needs to be broadened for use against China. “This is going to be a much bigger challenge for the EU in the future because EU companies will, when in doubt, always prioritise market access to China,” Hackenbroich says. The position of Germany is particularly crucial, and the country itself seems divided. Its main business lobby group, the BDI, called Beijing’s move against Lithuania “a devastating own goal.” But the German-Baltic chamber of commerce told the Lithuanian government that some companies would have “no other choice than to shut down production in Lithuania.”Tobias Lindner, state secretary at the German foreign ministry, set out his government’s position at an event earlier this month: “Trade policy is a matter for the EU. Period. And whoever imposes sanctions on Lithuania is imposing sanctions on the whole of the EU.” But diplomats say others in Berlin have privately tried to push a softer line. “What we have had, especially from the German government, calling up people in Brussels to try to tone down the response, has been very unhelpful,” says one EU diplomat.A German executive in the Baltics argues that the EU desperately needs to come up with a proper strategy for dealing with China, but questions whether the name of the Taiwanese office in Lithuania is the right case to force the issue. “We have much bigger stakes than this,” he says. “We should not fight over minor things [when] we have challenges 100 times bigger.”Lithuania is putting on a brave face for now. Armonaite, the economy minister, says that for all the furore, no company has yet left, and that Lithuania’s economy is still expected to grow strongly this year.But there is also a sense that unless a compromise is reached with Beijing, there is a danger that companies avoid Lithuania for future investments while the WTO case drags on for years. Janulevicius says it is likely to be a difficult two to three years. “The result, we will see only in 5-7 years’ time. It’s a big reputational issue,” says one Lithuanian automotive supplier.Huang is in no doubt what will happen if there is no pushback against China’s new coercion tactics. “If we cave to pressure this time, they will pursue it again,” the Taiwanese representative says. “Then China will rule the world.”Additional reporting by Guy Chazan in Berlin More

After months of rising inflation in the major advanced economies, a narrative is taking hold. It goes that the Bank of England and the US Federal Reserve have (better late than never) woken up to the inflation danger and are finally moving to make up for lost ground, while the European Central Bank runs a greater risk every day of falling behind the curve.This is why bond traders read a “hawkish pivot” into an ever-so-slight change of tone from the ECB, which has expressed “unanimous concern” over inflation, and accordingly sold off euro bonds, especially of high-debt governments. Surely, markets seem to think, the ECB must soon correct course — even overcorrect. Mustn’t it?One thing is true: the contrast between the eurozone and the large anglophone economies is striking. In the US and the UK, the employment rate remains more than 1 per cent below the pre-pandemic level and some 3 per cent below the pre-pandemic trend. Yet both the Fed and the BoE are beginning to press the brakes on aggregate demand. In the eurozone, conversely, the share of people in work is the highest, and the unemployment rate the lowest, on record. Yet the ECB seems relaxed about labour market pressures.This looks, on the face of it, the wrong way round. It would be more natural to worry about overheating in a labour market that has fully recovered from a downturn and to want to keep a foot on the accelerator in an economy still well short of jobs. Central bankers are doing exactly the opposite. But, as well as suggesting the ECB is behind the curve, this could equally indicate that the Fed and the BoE might be jumping the gun.One way to make sense of this topsy-turvy monetary policy messaging is to suppose that the missing American and British jobs are gone forever — that today’s situation is as good as it gets — while continental Europe has been spared any permanent scarring from the pandemic and so can expect the economy to take continued loose monetary policy in its stride.That is not implausible. Continental-style short-term work and temporary unemployment schemes did a much better job of keeping people attached to the workplace than the American temporary boost to unemployment benefits and ill-targeted “paycheck protection” spending. For its part, the UK deployed a European-style furlough, but from the standing start of a system that had traditionally hewed closer to US-style flexibility. That, plus the departure of European workers after Brexit, could explain today’s disappointing employment rate.Two big caveats pertain to this analysis. The first is just how surprising it would be, if true. The conventional wisdom, after all, is that continental Europe, while more protective of workers, is worse at getting them jobs than the tough-love Anglo-American model, especially in post-recession recoveries. If that has now changed, it is cause for a victory lap for the continental and Nordic traditions of social protection.The second caveat concerns the fact that economic output numbers tell a different story than labour market numbers. US GDP is currently well above its pre-pandemic level and closing in on its pre-pandemic trend. The eurozone, while it recovered its pre-Covid GDP level late last year, remains far below where it should be on the growth path. (By this measure, the UK looks distinctly continental.)This means the US has achieved remarkably better productivity growth. That justifies tolerating higher wage growth, too, without fearing a wage-price spiral. And Europe’s relatively weak output growth means it, too, may still have spare capacity to make up.The febrile narrative dominating today’s debate insists on emphasising signs of overheating and ignoring those of spare capacity — in particular the economy’s potential to expand the labour force in response to strong demand. That is precisely the reflex that recent strategy reviews by both the Fed and the ECB were intended to forestall.Both central banks have heeded lessons from the previous decade, when fears of excessive monetary stimulus foundered (or should have done) when supposed limits on jobs growth failed to materialise. The ECB has even formally endorsed temporary inflation above its target to secure the economy’s potential.Far sooner than expected, these principles are facing exactly the pressures they were adopted to resist. But it is in times like this that monetary policymakers show their mettle. Far from falling behind the curve, it is Frankfurt’s central bankers who are demonstrating how to hold their nerve. For [email protected] up for Martin Sandbu’s Free Lunch newsletter, ft.com/newsletters More