Economy

WASHINGTON (Reuters) – Since the Federal Reserve decided to keep interest rates on hold at its June 13-14 policy meeting, U.S. central bank officials have given every indication they are ready to approve another small rate increase when they gather again next week.But recent data suggesting inflation has begun to slow in a faster and more persistent way will likely intensify their debate over whether the coming move will be the last one needed, with policymakers honing in on the key issue of whether the economy has fully absorbed the impact of the aggressive monetary tightening to date or is only beginning to adjust.In one case, more rate increases might be needed to ensure “disinflation” continues; in the other, weakened price pressures are already in the pipeline, and doing more could cause unnecessary damage to the economy and the job market.Officials’ rhetoric has leaned towards further hikes beyond the July 25-26 meeting, when the Fed’s policy-setting committee is expected to raise the benchmark overnight interest rate by a quarter of a percentage point to the 5.25%-5.50% range.Fed Chair Jerome Powell has noted the majority view that two additional rate increases would be needed, and Governor Christopher Waller made the case for tighter policy in the central bank leadership’s final remarks before the blackout on public comments ahead of this month’s meeting.Last year’s rate increases “should hit economic activity and inflation much faster than is typically predicted,” Waller said, and thus “we can’t expect much more slowing of demand and inflation from that tightening.” While recent inflation data was encouraging, he said, “one data point does not make a trend.” Economists typically see the impact of monetary policy peaking at around 18 to 24 months after rate changes, but Fed officials have noted that their use of “forward guidance” to flag the path of policy means market rates adjusted well in advance of the rate hikes they rolled out beginning in March of 2022.Other Fed officials have hewed to the main strategic thrust of keeping rate-hike options open and not giving investors room to think the central bank is finished – undercutting the battle against inflation with looser financial conditions as a result.But arguably for the first time since the Fed’s first quarter-percentage-point rate hike in March 2022, the possibility that this upcoming move will be the last one has gained traction beyond the wishful thinking of investors and started to be supported by incoming data.’NEW EQUILIBRIUM’ Beyond the softened pace of consumer price increases in June, reports on import prices and producers’ input costs were both weaker than expected.The producer price index, in particular, suggests consumer inflation could keep slowing. The drop in import prices is important to Fed hopes that out-and-out declines in goods prices, which soared during the coronavirus pandemic, could offset service-sector inflation that has typically been higher and “stickier,” even before the pandemic. So far, this has occurred without major disruption in the job market, which sports a still-low unemployment rate of 3.6% and is spinning out new jobs and wage growth at rates higher than before the pandemic. A central point in the Fed debate is whether that amounts to a risk – a reason for inflation to remain high as households spend rising incomes – or a positive surprise that needs to be nurtured with patience about future rate moves.The current situation “still leaves us with the question whether inflation can settle while consumers are still spending and the labor market remains this robust,” Richmond Fed President Thomas Barkin said last week. The weak June inflation reading left him unconvinced it is on a steady downward path.Yet signs of a new status quo appear to be emerging in the job market, whether in the ongoing drop in the ratio of available workers to open jobs, a recent rise in the prevalence of part-time work, or in subtler signals. While the number of food service and accommodations industry workers remains a few percentage points below the pre-pandemic peak, for example, the industry’s contribution to real gross domestic product has increased from that point: It is doing more with less and may not need 2019 headcount levels.”There are more and more hints of ‘soft landing,’ heading to a new equilibrium,” said Nick Bunker, research director at the Indeed Hiring Lab, referring to a scenario in which monetary tightening slows the economy, and inflation, without triggering a recession. “It is trending towards a steadier but still-strong labor market” that echoes conditions from 2019, with participation rates recovering, a sustainable job-creation pace, and wages rising for less-well-paid occupations.’STRANGE BUSINESS CYCLE’ Until the Fed declares its inflation war at an end, however, economists and market analysts say risks to a benign outcome will remain. Jason Furman, a Harvard University professor who was the top White House economic adviser in the Obama administration from 2013 to 2017, still sees the underlying rate of inflation, by the Fed’s preferred measure, running around 3.5%.”At 3.5%, July won’t be the last time the Fed hikes,” Furman said in an interview. “I think we have learned almost nothing about what it will take to get inflation from 3.5% to 2% … My worry is that the last leg might require additional unemployment.” Ed Al-Hussainy, senior rates analyst at Columbia Threadneedle, meanwhile, is skeptical that the impact of rapid rate hikes has already been absorbed. “We have managed to generate this decline in inflation, that seems to be becoming more persistent, without doing a lot of damage,” he said. “Why?”Key rate benchmarks have on an inflation-adjusted basis shifted from negative to sharply positive, and “I think we have not seen the full effects” of that, he said. “To say we have the same economy with real rates at negative 2% as we do at positive 2%, I don’t buy it.”Fed officials have acknowledged data could be shifting in their favor, but it will take time for policymakers to accept what they are seeing as genuine and “lean in” to the idea that a soft landing may be in sight, Atlanta Fed President Raphael Bostic said earlier this month. Believing policy is operating with a long lag, Bostic favors holding rates steady.Chicago Fed President Austan Goolsbee, speaking to CNBC earlier this month, said policymakers shouldn’t be shy to show faith in an economy that has consistently surprised. “The premise is we need a recession to eliminate inflation,” Goolsbee said. “I don’t think that … This was a very strange business cycle.” More

OTTAWA (Reuters) – The Bank of Canada has shifted to a less prescriptive messaging strategy than it used in January when it signaled a rate-hike pause that reignited the housing market, which added to inflation and the need to resume tightening five months later.Last week after lifting rates to a 22-year high of 5.0%, Governor Tiff Macklem struck a more hawkish tone than when he announced a pause in January, warning the bank could hike again if economic data shows it is needed.That switch could leave the BoC less vulnerable to criticism when forecasts go awry, leaving investors and borrowers to arrive at their own conclusions in assessing the outlook for interest rates.”Every time (the members of the governing council) try to provide that hand-holding forward guidance, it doesn’t work,” said Derek Holt, vice president of capital markets economics at Scotiabank.Central bankers around the world have underestimated inflation and grappled with communication. Macklem came under a rare attack last year from opposition politicians for misjudging inflation and locking in to a rigid forward guidance.”We are turning the corner on inflation,” Macklem told reporters in January when the BoC became the first major central bank to announce a pause. “If economic developments and – in particular – if inflation comes down in line with our forecast, that will confirm that we have likely done enough.”The markets quickly priced in a half-percentage-point in cuts by the end of the year, and the slumping housing market recovered. The average sale price of a home increased 19% between January and May, according to the Canadian Real Estate Association.That jump in housing prices “is likely to persist and boost inflation by as much as 0.3 percentage points by the end of 2023, compared with the January outlook,” the BoC said last week.’IT MADE SENSE’Last week, Macklem defended the decision.”It made sense to pause,” he said, to assess the effect of the most rapid increase in rates in the BoC’s history. But then the economy outperformed the bank’s expectations, he added, which is something that has happened repeatedly in recent years.The central bank’s tightening campaign is a major concern for Canadians who loaded up on cheap mortgages and took on credit card and other debt in recent years. Household debt as a proportion of disposable income rose to 184.5% in the first quarter, near a record high, which means there is C$1.85 in debt for every dollar of household disposable income.Macklem did not use the word “pause” while announcing last week’s 25-basis-point hike, the second in as many months, though some analysts now expect the bank to do just that.”Now maybe you’re getting a certain maturity of the central bank that says, ‘We’re not going to do that again,'” Holt said. Though many economists are doubtful another rate hike is coming, money markets are still not shifting their bets toward a possible cut as they did in January, both because of the uncertainty of the inflation outlook and the bank’s threat to raise again if needed.Macklem has delivered misleading messaging before.He assured Canadians during the pandemic that rates would rise only in 2023 when it expected the economic slack to be absorbed, but the central bank began hiking rates in March 2022 as inflation spiked. In October 2021, Macklem forecast inflation would return close to the central bank’s 2% target by the end of 2022, only to push back that goal in January of this year to end 2024. Last week, the bank further delayed that target to mid-2025.Marc Chandler, chief market strategist at Bannockburn Global Forex LLC, said the fact that the BoC hiked not once, but twice starting in June after announcing the pause is evidence that it knew there was ground to be made up.”The June hike wasn’t a one-off … it wasn’t just an insurance policy, but (a sign) they think that they made a mistake.” More

A House select committee is requesting more information about a university collaboration that it said could help China gain access to cutting-edge research.A congressional committee focused on national security threats from China said it had “grave concerns” about a research partnership between the University of California, Berkeley, and several Chinese entities, claiming that the collaboration’s advanced research could help the Chinese government gain an economic, technological or military advantage.In a letter sent last week to Berkeley’s president and chancellor, the House Select Committee on the Chinese Communist Party requested extensive information about the Tsinghua-Berkeley Shenzhen Institute, a collaboration set up in 2014 with China’s prestigious Tsinghua University and the Chinese city of Shenzhen.The letter pointed to the institute’s research into certain “dual-use technologies” that are employed by both civilian and military institutions, like advanced semiconductors and imaging technology used for mapping terrain or driving autonomous cars.The committee also questioned whether Berkeley had properly disclosed Chinese funding for the institute, and cited its collaborations with Chinese universities and companies that have been the subjects of sanctions by the United States in recent years, like the National University of Defense Technology, the telecom firm Huawei and the Chinese drone maker DJI.It also said that Berkeley faculty serving at the institute had received funding from the Defense Advanced Research Projects Agency and other U.S. funding for the development of military applications, raising concerns about Chinese access to those experts.In April, for example, a team from a Shenzhen-based lab that describes itself as being supported by the Tsinghua-Berkeley Shenzhen Institute said it had won a contest in China to optimize a type of advanced chip technology that the U.S. government is now trying to prevent Chinese companies from acquiring, the letter said.It is not clear what role the university had in that project, or if the partnership, or the institute’s other activities, would violate U.S. restrictions on China’s access to technology. In October, the United States set significant limits on the type of advanced semiconductor technology that could be shared with Chinese entities, saying that the activity posed a national security threat.“Berkeley’s P.R.C.-backed collaboration with Tsinghua University raises many red flags,” the letter said, referring to the People’s Republic of China. It was signed by Representative Mike Gallagher, a Wisconsin Republican who chairs the committee, and Representative Virginia Foxx, a Republican of North Carolina who is the committee chair on education and the work force.In a statement to The New York Times, U.C. Berkeley said it takes concerns about national security “very seriously” and was committed to comprehensive compliance with laws governing international academic engagement. “The campus is reviewing past agreements and actions involving or connected to Tsinghua-Berkeley Shenzhen Institute” and would “fully and transparently cooperate with any federal inquiries,” it said.The university also said it had responded to inquiries from the Department of Education with detailed information about gifts and contracts related to the institute, that it was committed to full compliance with laws governing such arrangements, and that it “follows the lead of Congress and federal regulators when evaluating proposed research relationships with foreign entities.”Universities have also emphasized that foreign governments might have little to gain from infiltrating such partnerships, since academic researchers are focused on fundamental research that, while potentially valuable, is promptly published in academic journals for all to see.“As a matter of principle, Berkeley conducts research that is openly published for the entire global scientific community,” the university said in its statement.The letter, and other accusations from members of Congress about U.S. universities with partners in China, underscores how a rapid evolution in U.S.-China relations is putting new pressure on academic partnerships that were set up to share information and break down barriers between the countries.The Chinese government has sought to improve the country’s technological capacity through legitimate commercial partnerships, but also espionage, cybertheft and coercion. Those efforts — along with a program to meld military and civilian innovation — has led to a backlash in the United States against ties with Chinese academic institutions and private companies that might have seemed relatively innocuous a decade ago.The select committee, which was set up earlier this year, describes its mission as building consensus on the threat posed by the Chinese Communist Party and developing a plan to defend the United States. The bipartisan committee, which is led by Republicans, can provide legislative recommendations but cannot legislate on its own. It has been busily naming and shaming major companies and others over ties to China in congressional hearings, investigations and letters.Tensions between the United States and China are high, and some lawmakers have called for decoupling the two economies. But severing academic ties is a tricky prospect. American universities are geared toward open and collaborative research and count many Chinese scholars among their work force. China’s significant technology industry and huge population of science and technology doctorates make it a natural magnet for many research collaborations.Still, the rapid expansion of export controls in the United States is putting more restrictions on the type of information and data related to advanced technologies that can be legally shared with individuals and organizations in China. Under the new rules, even carrying a laptop to China with certain chip designs on it, or giving a Chinese national a tour of an advanced U.S. chip lab, can violate the law.The House committee has requested that the university provide extensive documents and information by July 27 about the partnership, including its funding, structure and technological work, its alumni’s current and past affiliations, and its compliance with U.S. export controls. More

The NewsChina’s economy slowed markedly in the spring from earlier in the year, official numbers released on Monday showed, as exports tumbled, a real estate slump deepened and some debt-ridden local governments had to cut spending after running low on money.The new gross domestic product data for the second quarter — from April through June — underlined what has been apparent for weeks: China’s recovery after abandoning its extensive “zero Covid” measures will be harder to achieve than Beijing and many analysts had hoped.The NumbersCovid not only still hangs over China’s economy; it also skews some of its official data. The main G.D.P. number reported by Beijing on Monday, comparing this year with the same quarter last year, showed that the economy expanded 6.3 percent. But that reflected improvement from a sharp slowdown in 2022’s second quarter, a period when China’s largest city, Shanghai, was in a two-month lockdown. More

Good morning. The role of artificial intelligence in filmmaking is a key point of friction in Hollywood’s big strike. Scriptwriters and actors are worried that AI-generated extensions of their own words and images will undercut their earnings power. But if they are worried, shouldn’t lawyers, doctors, journalists and other white-collar types — many of whom have weaker union representation than film and TV workers — be more worried still? Hollywood could be a test case for a much larger conflict between workers and capital. Curious to hear your thoughts. Send them to [email protected]. Banks results and the credit cycleJPMorgan Chase, Citigroup, and Wells Fargo all reported earnings last Friday. The results were not too far from Wall Street’s expectations. Given the rapid changes in the interest rate environment, analysts’ attention was mostly focused on whether asset yields are keeping pace with funding costs. As it turns out, that was mostly a wash in the second quarter, leaving interest margins stable. Trends in credit quality are of more interest to investors generally, however. Unhedged and everyone else is looking for evidence of stress at the economic periphery. Are consumers and businesses falling behind or defaulting on their loans at a greater rate? Results from the three banks suggest that the answer is no. Executives at all three banks used the word “normalisation”: while writedowns of bad loans are rising, they are rising gradually and remain below pre-pandemic levels. JPMorgan CEO Jamie Dimon set the tone, talking about consumer loans, and pointing out a credit-card charge-off rate of just 2.4 per cent. He said that the bank has been “over-earning” in its credit results, and he expected things to return to a normal trend before long — which would be a 3.5 per cent charge off rate. Revolving balances per card account are still below pre-pandemic levels at JPMorgan, too. Things are still unusually good on the credit front.The theme sounded by Dimon was repeated across all three banks and across most lines of business. Non-performing loans are stable to down, as well.This is consistent with the aggregate charge-off data from the Federal Reserve, which shows that as of the first quarter writedowns at US banks remained low:One exception to the normalisation trend is Wells Fargo’s $33bn portfolio of office real estate loans. Nonaccrual (more than 90 days delinquent) office loans at the bank more than doubled to $1.5bn between the first and second quarters, and the bank has made allowances for credit losses equivalent to 6.6 per cent of the office portfolio. A trend worth watching, and one that will probably worsen, but not a catastrophic one as of yet. It is, in short, hard to see a traditional credit cycle of any sort in the bank numbers. What the numbers show, as of now, is a big hangover from the pandemic. We may see more of interest in the regional bank reports. Unhedged will be following closely. More on the excess savings puzzleOn Friday, we wrote about the simplistic way in which we and other people have been thinking about post-pandemic excess savings. On a naive view, households spend the money received from stimulus programs, and then it the money is gone, and aggregate spending slows. But this is wrong, because one household’s spending is another’s income. That does not mean that the stimulative effect of excess savings lasts forever, of course. Instead, it means that the stimulus cash moves through the economy until it ends up with a household (or company or government agency) that doesn’t spend it. We wrote:Eventually some amount of [the excess savings] will get to someone who will simply hold on to it, or use it to pay off debt. If the money simply sits in a deposit account, and the bank with the deposit does not make a new loan on the back of that deposit, the money falls into a sort of coma. On the other hand, if the money pays off a debt, it is destroyed — the reverse of the process by which lending creates money. The “person” who pays off the debt and destroys the money might be the government, if they use a tax payment to settle a debt that is not replaced with a new one. Innes McFee, managing director at Oxford Economics, emailed over the weekend with some more perspective on this. He emphasised that tax is a particularly important part of the picture. In a note last year, he estimated that tax payments on transactions, dividends and so on took a $745bn bite out of the total stock of excess savings (so perhaps a third of the total). He notes, however, that most of these taxes were likely paid at the high end of the income distribution. But at the high end of the income spectrum, marginal propensity to spend is low, so the savings paid in taxes may not have been very economically potent, anyway (more on this dynamic below).He also notes that there is evidence that households are indeed using stimulus to pay down debt, destroying excess savings. He points to this chart from the Fed (made with data from Standard & Poor’s), showing that credit card payments, measured as a proportion of outstanding balances, has been well above the trend:

Finally, he makes the point that, in an inflationary environment, excess savings’ impact on the economy could constrain themselves: the extra spending they encourage drives inflation up, bringing real incomes down and discouraging spending. Excess savings create an unstable equilibrium.Several readers sent along a paper called The Trickling Up of Excess Savings, published early this year by Adrien Auclert, Matthew Rognlie, and Ludwig Straub. It attempts to model the way excess savings “trickle up” through an economy, finding their way to rich households with a low propensity to spend, driving their economic impact steadily down. The paper argues that, if you assume that the excess savings are initially widely distributed across households but that poorer households will spend more of the money, excess savings must move slowly up the income scale, steadily diminishing their economic impact. All the same, the model acknowledges that one household’s spending is another’s income, so despite the trickling up effect the stimulus effect still lasts longer than suggested by naive models in which the savings disappear when spent. The authors suggest that there could be a notable impact (perhaps half a percentage point of GDP) on consumption five years after excess savings’ peak, though tighter monetary policy could shorten the timeframe. The takeaway for investors of all this? The pro-growth impact of excess savings may be with us for a while. A sharp drop off in consumption in the third or fourth quarter, driven by the exhaustion of the excess savings stock, is unlikely. Instead, taxes, monetary policy, trickling up, and possibly sustained inflation will cause the impact to diminish slowly but steadily over several more years. One good readMusic festivals are bad. More

Good morning. The EU and Tunisia last night agreed to co-operate on curbing migration, but did not yet seal a large financial assistance package. And Russia has seized Danone’s local subsidiary and a brewer owned by Carlsberg, in the Kremlin’s latest escalation against western businesses.Today, I explain why Brazil’s president is the man everyone will be watching at this week’s summit between EU and South American leaders, and we have news on a proposal by the European parliament to ban spying on journalists (which countries such as France would like to avoid).You got me on my knees, LulaMore than twenty leaders from the Caribbean and Latin America descend on Brussels today for a summit with the EU’s own leaders, but one matters more than all the rest: Brazil’s Luiz Inácio Lula da Silva.Context: The first EU-CELAC summit for eight years begins today, in a bid to rebuild, restart or in some cases, resurrect Europe’s standing in the region. The leftwing Lula’s return as Brazil’s president in January was initially hailed by the EU as a great chance to get things back on track. It hasn’t worked out that way. Lula’s “neutral” stance on the war in Ukraine, his opposition to EU-proposed environmental safeguards in the still-unsigned Mercosur trade agreement, and his warmth towards Beijing and Moscow have laid bare Brussels’ standing with the region’s linchpin state.Spain, which holds the EU’s rotating presidency, desperately wants the two-day summit to be a success (though prime minister Pedro Sánchez could be forgiven for being a little distracted with his job on the line in six days).The pre-summit antics have not augured well. Preparatory discussions saw some Latin American nations demand the removal of a condemnation of Russia’s invasion of Ukraine in the draft conclusions, and tried to add a demand for European reparations for the transatlantic slave trade. Many of the visiting leaders quite understandably roll their eyes at the recent spike in European interest in their countries, knowing that a quest to buy up their critical raw materials is the main reason.Still, at least Lula is coming. And for many, whether it ends up a success depends on how he feels when it concludes. While a Mercosur deal is extremely unlikely, positive statements from the Brazilian bellwether on future co-operation would signal some progress for Brussels in its bid for more regional relevance — and to catch up with China.“Latin America is not an easy partner,” the FT’s editorial board wrote last week. [But] those difficulties have not put off the Chinese . . . Next to them, Europe risks becoming sidelined.”It may take more than just a charm offensive to change that, but it’s not a bad place to start.Chart du jour: Bullet time

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Factories in Europe have stepped up output to replenish national ammunition stockpiles. But industry executives say that despite national pledges to increase defence spending and new procurement initiatives by both Nato and the EU, progress has been slow.I spyThe European parliament will put forward a de facto ban on the use of spyware against journalists, as MEPs hit back at “dangerous” proposals by EU countries that would enable intrusive tech, writes Ian Johnston.Context: The EU’s Media Freedom Act aims to protect media independence and pluralism, and ensure editorial freedom. But media groups warn that a suggested carve-out pushed by member states, led by France, to allow security services to spy on journalists will have the opposite effect.Tomorrow, the parliament committee responsible for parliament’s take on the use of spyware will vote on its own proposal on the media rules.According to a draft seen by the FT, MEPs want protections against spyware used to access data related to journalists’ work, including accessing information about journalists’ family members or sources.The sections on spyware that the MEPs will probably adopt contradict the member states’ position to allow authorities to spy on journalists on national security grounds. Both parliament and the council of member states need to agree before the law can come into force.Ramona Strugariu, the MEP from the liberal Renew group leading the negotiations, said the council’s approach was “really dangerous”. “I think that it doesn’t have anything to do with democracy and freedom of speech,” Strugariu added. Parliament’s counterproposals will enable surveillance tech as a last resort in the investigation of serious crimes, but only if ordered by a judge and not to uncover information relating to a journalist’s professional activity.Geoffroy Didier, a conservative MEP also responsible for the legislation, said: “There’s a risk of a clash between the parliament and the council. If the French government puts up a red line, we’ll put up a red line.” What to watch today Brazilian president Lula meets Belgian King Philippe.G20 finance ministers and central bank governors meet in Gandhinagar, India. Now read theseCash call: The EU must boost its financial muscle after the European elections if it wants to compete with US green subsidies, its economy commissioner tells the FT.Do your part: As raising climate targets becomes more and more costly, the EU wants big polluters like China to share the burden of cutting emissions.Finance fuel: Turkey has tripled its petrol taxes in a bid to get its disastrous-looking budget back into shape. More

Looming over the Yangtze River, the Wuhan Greenland Center was meant to be Central China’s answer to the Burj Khalifa, the world’s tallest building.When it was unveiled in 2011, the tower was intended to have 120 floors, host a five-star hotel and attract Wuhan’s rich and powerful with its helipad and cathedral-sized lobby. There was to be an expansive Communist party “service centre” where elite patriots can conduct their political affairs in style while enjoying the view. Marketing materials describe it as a “building for individuals who can personally impact GDP”.Today, however, the colossus stands as a monument to the collapse of China’s real estate bubble and the growing challenges facing the world’s second-largest economy.On the orders of President Xi Jinping, its planned height had to be reduced mid-construction by 25 per cent to 475m. The hotel has yet to open and many wealthy apartment owners did not receive keys to their properties on time — a common situation across China following the property market’s implosion in the past three years. “Here most of the homebuyers are rich, so they can put up with very long delays,” explains one person close to the building’s developer, who promised that it would be fully completed by the end of this year — six years late. 

Property is just one of the indicators flashing red in China’s $18tn economy. After bouncing back in the first quarter from brutal Covid restrictions last year, when authorities locked down large cities including Shanghai, everything from trade to industrial profits and consumer prices have underperformed analyst expectations in the past few months.China on Monday reported gross domestic product grew 0.8 per cent during the second quarter compared with the previous three months. This represented a slowdown from the first quarter, when the economy expanded 2.2 per cent.The weak performance is prompting growing calls for China to resort to the playbook of the past by launching a large monetary and fiscal stimulus to support the traditional, debt-fuelled growth engines of infrastructure and property.But President Xi Jinping and his top policymakers are adhering to a stance they call dingli, or “maintaining strategic focus”. Many economists take this to mean continuing to reduce debt, especially in the heavily overleveraged property sector while pursuing global leadership in advanced technology and other strategic areas of the economy, such as a transition to green energy.“Xi Jinping does not define economic success in terms of GDP growth,” says Arthur Kroeber, founding partner and head of research at Gavekal Dragonomics. “He defines it in terms of tech self-sufficiency.” As long as the government can hit its targets on this front, he says, “then his calculation is we can figure out how to spread the growth enough to keep people content”.The question is, with the engines of growth stalling, will Beijing be able to stay the course? Or will the old calculus that it needs to maintain a certain amount of growth to ensure social stability come into play — paving the way for a return to large-scale stimulus?Trade troublesThe problem for Xi, who began an unprecedented third term in office in March, is that during the second quarter not only property but another of China’s key growth engines — trade — also slowed sharply. During the pandemic, the world turned to China for electronics to help people work at home, and for personal protective gear to fend off Covid. Online shoppers also helped keep China’s trade figures buoyant, offsetting the negative impact of its own strict lockdowns. But this year, as western central banks raised interest rates to combat inflation, demand for China’s exports fell. In June, they suffered their biggest year-on-year decline since the pandemic started, falling 12.4 per cent in dollar terms, official data showed on Thursday.

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Negative sentiment on trade has been exacerbated by the geopolitical tensions with the US, which have led western companies to talk more loudly about “de-risking” supply chains away from China. The falling trade numbers are hitting Chinese manufacturers, such as Richard Chan, managing director of Golden Arts Gift & Decor, which makes artificial Christmas trees and decorations in Dongguan, southern China.Chan says his company, which exports about 80 per cent of its products to the US and Europe, saw a 30 per cent drop in orders this year compared with last year. It typically receives most of its orders by May each year.Inflation has flattened the market, the Hong Kong-based businessman says. For example, “a Christmas tree that used to cost a retail price of €100 now costs €150, and people are no longer buying it”. His factory has hired half the number of summer temporary workers for the company’s peak manufacturing months compared with pre-pandemic years. “The manufacturing industry is dying,” Chan adds. “The outlook is pessimistic . . . And we can only try to cut costs here and there.”Other manufacturers are getting squeezed not just by falling exports, but also by weak demand domestically for construction materials and household durable goods because of the property downturn.Danny Lau of Kam Pin Industrial says his company has suffered from a shrinking market and stronger competition in mainland China © David Wong/South China Morning Post/Getty Images“Doing business is more difficult nowadays in mainland China, with a smaller market and stronger competition,” says Danny Lau of Kam Pin Industrial, which produces aluminium curtain walls for residential and commercial buildings from its factory in southern Guangdong province.The US typically accounts for roughly 30 per cent of Lau’s business, with the rest mostly from clients in China. He predicts a significant recovery only by 2025, when the global economy improves.Orders within mainland China also fell more than 60 per cent in the first six months of 2023 year-on-year, he says. A recovery would depend largely on Beijing’s stimulus policies and any easing of US-China tensions, he adds.On the domestic front, there are signs that Chinese consumers and private businesses are still dealing with the fallout from the pandemic, particularly from last year, when several large cities endured long lockdowns, economists say. While the US and other western countries supported consumers with direct handouts, China’s stimulus was mostly directed at the supply side. The result is a cyclical slump in consumer and business confidence, according to economists. Domestic demand has recovered for services such as local tourism, but consumers are not making big-ticket purchases.“You have orders and earnings coming down in the past 16 months, so it is very hard for businesses to be confident in that environment,” says Tao Wang, chief China economist at UBS Investment Bank. “Businesses do not want to expand because many of them have excess capacity.”

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At the same time, the government launched crackdowns on several important sectors during the pandemic years, starting with limits on real estate company leverage and extending to ecommerce platforms, such as internet billionaire Jack Ma’s Ant Group, and finance.There are hopes that the state is now calling a truce on some of these measures.The government announced a Rmb7.1bn ($984mn) fine for Ant last week that, despite its size, some analysts saw as a positive step — possibly signalling an end to the so-called “rectification” of the internet group. China’s number two official, Premier Li Qiang, also met tech executives from TikTok owner ByteDance, food delivery group Meituan and Ma’s Alibaba Cloud, and assured them the government would normalise regulations. During the pandemic years the government launched crackdowns on ecommerce platforms such as Jack Ma’s Ant Group. It has since attempted to normalise regulations © Fabrice Coffrini/AFP/Getty ImagesThis follows a Chinese government charm offensive aimed at foreign governments and businesses, culminating in the resumption of dialogue with Washington after a long hiatus, with US Treasury secretary Janet Yellen visiting Beijing this month. “The authorities have tried to assure the private sector about the normalisation of regulations,” says UBS’s Wang. But she adds: “The private sector is probably waiting for more concrete specific policies to support that kind of rhetoric and even when those specific policies are implemented, it will probably take them some time to feel reassured.”Holding the lineAt a small dinner of local businessmen in Wuhan, the talk focused on the usual topics — who had the best contacts among the local Communist party lingdao, or bosses, and jokes about which baijiu, or Chinese liquor, was favoured by the country’s top leaders. Most were still struggling after a tough few years during the pandemic, which started in Wuhan. The city’s streets, which were bustling pre-pandemic, are now much quieter, especially centrally located restaurants, many of which closed during Covid. But some cited evidence that government policies to support the economy, such as infrastructure finance, were helping keep businesses afloat. “Things are bad but we are managing to get by,” says one businessman specialising in the construction of tunnels and other government-funded civic works.One former senior government official in Wuhan says the slowdown this year was partly because companies built up inventories in 2022 during the lockdowns. A sharp fall in the producer prices index in June was related to this, he says. “There is a lot of inventory. You can’t sell so you cut prices.”But he says the pace of recovery so far is conforming to expectations. “A sick person who is recovering cannot be expected to run a marathon the following year,” he says. This point was reinforced last week by Liu Guoqiang, deputy governor of the People’s Bank of China, who said most countries took a year to recover from the end of Covid restrictions. China only abandoned its pandemic controls six months ago.The question remains, however, whether the government can hold the line and avoid having to stimulate the economy further if things continue to get worse this year, analysts say. 

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The property sector poses the biggest challenge. After stabilising early in the year, it has slipped again in recent months. According to a sample of 25 cities, prices of existing homes declined by 1.4 per cent in June compared with May, accelerating falls in the previous months, Nomura said, citing Beike Research Institute data.The government this week announced that a previous credit support plan for developers would be extended by a year. It has also cut benchmark lending rates and announced other measures to support the sector. But there are doubts whether these will stabilise the market. Developers do not want to invest and consumers do not want to buy, particularly after the bankruptcy of Evergrande, one of the country’s biggest and most indebted groups, says one real estate expert in Wuhan. “You could not have imagined that a developer like Evergrande would have exploded overnight. Buyers feel insecure about the market,” he says.The lingering problem was the huge number of unfinished housing projects in the market, which he estimates at 250 in the province of Hubei alone, of which Wuhan is the capital.The central government had channelled some funds to local authorities to help developers complete these projects — considered essential to restore consumer confidence. But local governments were reluctant to pick which developers should receive them for fear of being accused of favouritism.Local governments’ own finances in many cities are in dire straits, as revenue from land sales to developers vanishes and their finance vehicles, known as LGFVs, which often invest in low-return infrastructure projects, struggle to repay creditors. The Wuhan real estate expert says Beijing may not want property to be used for short-term stimulus, but there’s a lot of pressure to do so at local level. “Local people expect a big stimulus but it’s not happening,” he says.No bazookas comingMany economists believe, however, that things will have to get worse before Xi Jinping yields and announces a significantly bigger stimulus effort. Few in any case expect anything at the scale of the “bazookas” of the past, such as after the 2008 global financial crisis, when China injected Rmb4tn ($559bn) into the economy. While the financial markets clamour for stimulus, Xi and his policymakers evidently believe the property slowdown is a necessary, if painful adjustment, to the old debt-ridden economic model, economists say. 

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Kroeber of Gavekal Dragonomics says the general perception is that the leadership is more sanguine than the markets on the property crisis and the slow recovery in consumer confidence. While growth would probably hit the target of 5 per cent this year, Xi might be prepared to let it drop further in the coming years as the economy adjusted to the new reality, he says. The calculation would be that most families had already bought their own homes and private businesses would adapt to the new, lower growth trajectory. For Xi, he adds, most important is hitting the overarching strategic objectives of technological self-sufficiency and security as rivalry with the US picks up. “My bet would be that this works pretty well for a long time,” Kroeber says. “Most people in China have done OK over the past 30 years.” In sectors such as Wuhan’s depressed real estate industry, however, that message will be far from welcome. At a showroom on the city’s outskirts, far from the Greenland Center, another tower is rising above semi-derelict houses that were acquired for demolition at the height of the boom. Inside, a sales person confides that business is so bad, she has had zero customers in the past couple of months. When her boss cut prices, people who had previously bought into the development got angry.“They were threatening to launch a protest,” she says.Data visualisation by Andy Lin More

The gulf between price pressures in the US and the UK is likely to widen to levels not seen since the late 1970s this week, as Britain increasingly becomes a global inflationary outlier. Figures out last week confirmed US consumer price inflation is abating fast, with the annual figure for June falling to a two-year low of 3 per cent. That contrasts with economists’ expectations that last month’s CPI reading for the UK, due out on Wednesday, will come in at above 8 per cent. As of Friday afternoon, economists polled by Reuters expected, on average, a figure of 8.2 per cent for June. If they are right, that would mean UK inflation is now 5.2 percentage points higher than in the US — the widest gap since November 1977, when the country was beset by economic stagnation and political strife. “The drop in US inflation shines a light on the UK’s persistent inflation problem,” said Victoria Scholar, head of investment at Interactive Investor, an online investment service.

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Economists blame a combination of EU-style high energy prices and US-style labour shortages for the UK becoming the G7 economy most plagued by inflation. “Inflation is higher in the UK than the US because it has suffered a worse energy shock, worse labour shortages, and goods inflation rose later and subsequently started to fall later than in the US,” said Simon MacAdam, economist at research firm Capital Economics. Food price inflation, another important aspect of the surge in global prices, has also fallen faster in the US and much of Europe — partially because of Britain’s reliance on imports and weather limiting crop supplies. Historically the US and UK inflation measures have tended to track one another. However, over the past year, a gap has emerged. US inflation began declining during the autumn of 2022 after hitting its highest level in decades last June on the back of falling energy costs and slowing food inflation, while UK inflation continued to climb during the autumn on the back of a surge in European energy prices and accelerating services price growth. While UK inflation has declined since hitting a peak of 11.1 per cent in October, it has done so less dramatically than elsewhere in Europe. In the eurozone, where inflation hit a high of 10.6 per cent last October, the annual rate is now 5.5 per cent with price growth in Spain falling even below the European Central Bank’s target of 2 per cent.

In emerging markets, inflation is also plummeting as the after effects of the coronavirus pandemic and surge in commodity prices during the early stages of the Ukraine war drop out of indices. In Brazil, price pressures fell from more than 12 per cent in April 2022 to only 3.2 per cent in June. In China, price pressures are non-existent, with the world’s manufacturer-in-chief immune to the surge in producer prices that has contributed to inflationary pressures elsewhere. It also has substantial stores of grain and continues to purchase large amounts of energy from Russia. The widening gap between the UK and the US comes despite the Bank of England abandoning its near-zero interest rate policy ahead of the Federal Reserve.

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The Fed first raised rates in March 2022, while the BoE’s hikes began in the autumn of 2021. However, the Fed moved more quickly once it started to tighten, raising rates by 5 percentage points in just over one year. The ECB did not begin raising interest rates until the summer of 2022. Susannah Streeter, senior investment analyst at asset manager Hargreaves Lansdown, said strong wage growth raised the prospect of inflation remaining high for some time yet in the UK, “especially with consumer spending proving to be far more resilient than forecast”. More