MNI INTERVIEW: Fed Could Soon Lean Toward Rate Hikes-Giannoni

Federal Reserve officials are increasingly worried about high inflation and could start thinking about hiking rates soon if price pressures do not ebb, former Dallas Fed research director Marc Giannoni told MNI. 

“If inflation does not come down as we would expect and as the FOMC is expecting, then they will need to make some adjustments, then I would imagine they hike,” said Giannoni, now chief U.S. economist at Barclays, in an interview. 

He still thinks the most likely outcome is for the Fed to remain on hold until the end of 2027, but sees a “narrow path” to avoiding rate increases given the elevated inflation figures. (See MNI INTERVIEW: Fed Right To Hold Off On Hikes For Now - Keen) 

HAWKISH DISSENTS

Indeed, he noted the possibility of hawkish dissents as early as the July meeting, given sentiments expressed in minutes to the June decision.

“It’s quite possible. We had participants saying they would have favored a hike as early as June. They could get along with a hold, but if they were left to their own devices they would have preferred to hike. Those individuals will almost surely want to hike again in July,” he said.

The only thing FOMC members need to nudge them away from a wait-and-see stance and into hiking mode, Giannoni said, is for inflation to appear to be settling well above target rather than following the gradual decline officials expect after an energy-related bump. “If that does not happen, we are pretty close to having them switch to hikes earlier." 

While inflation pressures have been exacerbated by tariffs and the Iran war, Giannoni said the outlook for prices was not favorable even before the start of the conflict. 

The most important inflation surprise of the year has been the boost to prices from an ongoing boom in AI investments, which might eventually become disinflationary but right now is working in the opposite direction, he said. 

“The biggest risk and the biggest factor to us that affects PCE prices is this inflation in categories like software and computer accessories, which is related to the AI investment boom, the huge demand for chips and memory and things of that sort,” he said. 

COMMUNICATIONS VACUUM

Giannoni, also a former New York Fed staffer, said he welcomed some of Chair Kevin Warsh’s changes to communications, but hopes he does not take central bank circumspection a step too far, leaving financial markets to guess how the Fed will react to incoming data. 

A much shorter policy statement, for instance, is a welcome change, he said. Warsh’s critiques of shortcomings in the Summary of Economic Projections are also justified. 

“I think the dot plot has long been recognized as having flaws, in particular because it presents a simple projection by each individual under a certain scenario that can be completely different across individuals,” he said. 

That doesn’t mean it should be jettisoned, but rather replaced with something that offers more clarity and information rather than less, he added. “Moving away from that without having a good replacement, I think would be very problematic.”

At the same time, Giannoni would like the new chair to offer more detail both on how he is thinking about the current state of the economy as well as some hints of the Fed’s reaction function under his tenure. 

“This idea that somehow financial markets are going to derive pure signals about the economy and its future when they don’t get that communication at the central bank – it’s a risky operation,” he said. “Market participants have no choice but to form expectations about what the Fed is going to do. If the Fed doesn’t say anything, then you go by what you have, and you may misinterpret what they say.”

MNI POLICY: Weak Yen Adds Risk To BOJ's Policy Direction

Bank of Japan officials are concerned that only a weaker yen will persuade Prime Minister Sanae Takaichi that further rate hikes are necessary, but if markets begin dictating monetary policy, the eventual tightening cycle could prove steeper than if the BOJ responded primarily to economic and inflation developments, MNI understands.

Over time, if Takaichi's government remains in power, it is expected to appoint more reflationist members to the Policy Board and senior leadership, gradually shifting the BOJ's policy stance. However, this is a long-term process.

A weaker yen and rising government bond yields driven by the market's inflation and fiscal concerns could make further BOJ tightening politically acceptable. However, the Bank risks raising rates further than otherwise necessary if it is forced to tighten mainly in response to market pressure.

Such market-driven tightening is particularly problematic because it may fail to halt further yen weakness while locking the Bank into an unwanted policy path.

Nevertheless, the BOJ believes it must continue raising the policy rate as upside risks to inflation increase to avoid falling behind the curve. At its June meeting, the Bank also highlighted the risk that underlying CPI could overshoot its 2% target, signalling that the pace of tightening could accelerate if necessary. (See MNI POLICY: Weak Yen Stokes Concern; Govt Clouds Rate Path)

A rate increase implemented against the government's wishes would also strain relations between the BOJ and the administration, add to market volatility and ultimately influence future appointments.

Governor Kazuo Ueda's five-year term, along with those of both deputy governors, expires in April 2028. Market participants have discussed former Deputy Governor Masazumi Wakatabe and former Executive Director Tokiko Shimizu as potential candidates for governor or deputy governor, with some also viewing Shimizu as a possible successor to Ueda.

Wakatabe serves on the Council on Economic and Fiscal Policy, a government advisory panel that recently called for "appropriate monetary policy."

The five-year terms of hawkish Policy Board members Naoki Tamura and Hajime Takata also expire in July 2027, giving Takaichi the opportunity to appoint more reflationist successors.

GOVERNMENT'S RIGHT TO DELAY

Takaichi also has the authority to postpone a policy decision until the next meeting, making such intervention more likely when the BOJ is preparing to raise rates. Ahead of tightening, the Bank typically sounds out the government's position through informal communication to avoid unnecessary confrontation at the policy meeting.

Ueda's June 3 speech to business leaders, which strongly signalled a June rate hike, followed his May 22 meeting with Takaichi, leading some observers to conclude he had secured the government's tacit approval before the June 15-16 policy meeting.

If the BOJ continues this approach, however, meetings between Ueda and Takaichi ahead of policy meetings could themselves become policy signals. To avoid creating that impression, such meetings may eventually need to take place before every policy meeting, regardless of whether the BOJ intends to change rates.

The difficulty is that bilateral meetings take place after Ueda or a deputy governor has delivered a speech strongly signalling a near-future rate hike. Once the BOJ has sent such a policy signal, reversing course becomes difficult even if Takaichi opposed the move at the subsequent meeting. Failing to follow through after clearly signalling a rate increase would undermine the BOJ's credibility and risk destabilising financial markets.

MNI INTERVIEW: Trade Delays BOC Hike Until Late 2027-Stillo

The drag from U.S. tariffs remains the key risk for Bank of Canada policymakers, likely delaying any rise in interest rates from Governor Tiff Macklem until late next year despite the inflation threat from higher oil prices, a former official from the country's largest province told MNI.

U.S. President Donald Trump's failure to renew the USMCA pact on July 1 and opt for annual reviews puts more focus on damage to Canada's exports and investment says Tony Stillo, former forecasting manager at Ontario’s finance ministry now at Oxford Economics. The Iran conflict remains a risk but has yet to disrupt long-term inflation expectations Macklem has focused on as a condition for hikes  Stillo says.

“Slack in the economy is one of the reasons you're not going to see inflation get out of hand, even with the what we've seen to date with oil prices,” Stillo said. (See: MNI INTERVIEW: Carney-Trump Deal Will Include Tariffs-Chamber)

Growth and the labor market will remain weak through this year while business activity shows a mix of gains in commodity firms and more hesitation to spend by firms linked to U.S. trade, he said. Before the levies on steel, aluminum and autos, three-quarters of Canada's exports went to the United States.

POLITELY COMMUNICATING

Macklem's last rate decision said significant new U.S. penalties could require a cut to the 2.25% rate, but also that if inflation spreads beyond energy prices he may need consecutive hikes.

“They're politely communicating that monetary policy is caught in a bind -- they use the word dilemma -- because they can't address the dual factors at play in both the Iran-U.S. conflict and its fallout for higher prices and weaker economy. The same thing with what could happen with a trade deal,” Stillo said.

That wide range of guidance matches the unusual times the economy is in, and Stillo said officials will remain guarded even when the economy starts taking a clear direction. (See: MNI INTERVIEW: BOC Can Delay Hike To Neutral Til 2027-Mc Mahon)

“I don't think they'll just say that we're moving towards this,” he said. "They don’t want to be burned, and I think they're going to be prepared to still say, you know, we're living in uncertain times.”

EASING BIAS

“The worst scenario for Canada or any country globally is a poly-crisis, where all of these things happen all at once. That's where you really get some turbulence, to say the least.” 

In a scenario without a long rate hold, Stillo's view is the cut scenario is more likely because of the slow recovery from the tariff hit. 

“I think there's an easing bias,” he said. “The Bank is going to be nimble and respond to whatever the economy needs. They're in a reasonable place now.”

“Hopefully the Iran situation is largely contained, but that's why they were saying we could hike if we need to. If that's what the economy needs for stable prices and stable inflation and the best for the economy overall, then they'd hike.”

MNI INTERVIEW: Trade Delays BOC Hike Until Late 2027-Stillo

The drag from U.S. tariffs remains the key risk for Bank of Canada policymakers, likely delaying any rise in interest rates from Governor Tiff Macklem until late next year despite the inflation threat from higher oil prices, a former official from the country's largest province told MNI.

U.S. President Donald Trump's failure to renew the USMCA pact on July 1 and opt for annual reviews puts more focus on damage to Canada's exports and investment says Tony Stillo, former forecasting manager at Ontario’s finance ministry now at Oxford Economics. The Iran conflict remains a risk but has yet to disrupt long-term inflation expectations Macklem has focused on as a condition for hikes  Stillo says.

“Slack in the economy is one of the reasons you're not going to see inflation get out of hand, even with the what we've seen to date with oil prices,” Stillo said. (See: MNI INTERVIEW: Carney-Trump Deal Will Include Tariffs-Chamber)

Growth and the labor market will remain weak through this year while business activity shows a mix of gains in commodity firms and more hesitation to spend by firms linked to U.S. trade, he said. Before the levies on steel, aluminum and autos, three-quarters of Canada's exports went to the United States.

POLITELY COMMUNICATING

Macklem's last rate decision said significant new U.S. penalties could require a cut to the 2.25% rate, but also that if inflation spreads beyond energy prices he may need consecutive hikes.

“They're politely communicating that monetary policy is caught in a bind -- they use the word dilemma -- because they can't address the dual factors at play in both the Iran-U.S. conflict and its fallout for higher prices and weaker economy. The same thing with what could happen with a trade deal,” Stillo said.

That wide range of guidance matches the unusual times the economy is in, and Stillo said officials will remain guarded even when the economy starts taking a clear direction. (See: MNI INTERVIEW: BOC Can Delay Hike To Neutral Til 2027-Mc Mahon)

“I don't think they'll just say that we're moving towards this,” he said. "They don’t want to be burned, and I think they're going to be prepared to still say, you know, we're living in uncertain times.”

EASING BIAS

“The worst scenario for Canada or any country globally is a poly-crisis, where all of these things happen all at once. That's where you really get some turbulence, to say the least.” 

In a scenario without a long rate hold, Stillo's view is the cut scenario is more likely because of the slow recovery from the tariff hit. 

“I think there's an easing bias,” he said. “The Bank is going to be nimble and respond to whatever the economy needs. They're in a reasonable place now.”

“Hopefully the Iran situation is largely contained, but that's why they were saying we could hike if we need to. If that's what the economy needs for stable prices and stable inflation and the best for the economy overall, then they'd hike.”

MNI INTERVIEW: AI Should Boost Growth More Than Rates

The uplift to growth from AI should outpace increases in the neutral level of interest rates, boosting government finances, though it could also undermine the tax base, the UK Office for Budget Responsibility's David Miles told MNI.

While the baseline scenario in the OBR’s annual fiscal risks and sustainability report released this week assumed the difference between the neutral level of rates and growth tends to converge to around 25 basis points, Miles noted that AI-driven productivity gains could narrow this gap in borrowers’ favour.

“If AI boosts growth, I suspect any upward impact on [rates] will be lower, so that would be fiscally helpful,” Miles, a member of the OBR’s Budget Responsibility Committee, said in an interview.

The OBR’s incoming head Jonathan Haskel has argued that the effect of AI on the neutral level of interest rates should be minimal, given that the inflation-dampening effect of productivity gains should be counteracted by a boost to consumption as the technology fuels anticipation of gains in wealth. (See MNI INTERVIEW: AI Boom Doesn't Justify Lower Rates - Haskel)

Miles noted that AI’s effect on the government could also come via its revenues. It could shift "the distribution of income away from labour income toward capital income ... [which] tends to be a lot more difficult to tax.”

However these effects are all uncertain.

"I think risk is the right word. I mean, it makes it difficult to predict how this will play out. What timescale? What's the impact on jobs? What's the impact on the distribution of income?" he said.

However, he noted: "There's always lots of uncertainty, but the fiscal challenges generated by uncertainty are just a different order of magnitude when you start with a debt-to-GDP ratio of 100% as opposed to 20% or 30% or 40%."

GILT HOLDERS

The UK’s fiscal position is complicated by a change in composition of holders of its government debt, with a higher proportion now taken by overseas investors and hedge funds as defined-benefit pensions decline, Miles noted. (See MNI INTERVIEW: Lower Long Gilt Demand Risks Volatility - Miles)

"The UK, in that sense, is in a slightly more sensitive, some people might even say fragile position, than some countries with even higher debt than the UK [such as] Japan," where almost all the buyers of government debt are Japanese investors, he said.

Another shock along the lines of the pandemic crisis which have pushed debt to GDP to 95% "really would push debt into regions where we should become nervous about whether about the ability to carry on funding at ever higher levels of debt," Miles said.

MNI INTERVIEW: Germany Postpones Tough Adjustment-EFB's Janeba

Germany will face a tough job restraining spending next year in order to again avoid a European Union excessive deficit procedure, though there are encouraging signs that the government is prepared to push through reforms and accelerate the country’s transition from an outdated economic model, European Fiscal Board Member Eckhard Janeba told MNI.

Berlin only dodged an EDP this year because spending growth turned out below the country's EU-approved reference trajectory over a two-year period, Janeba said in an interview, adding that the government has only postponed a tough economic adjustment.

"Further down the road it will be an issue as to whether it's credible to hold spending growth at the level that has been promised. That will become more of a political issue as we come closer to the next election." 

The country is running a deficit close to the 3% of GDP limit even after the EU’s Escape Clause for defence spending has been taken into account, he noted.

"It depends really on the denominator, on whether growth will pick up. The projections are very modest - around 0.9% - but every year now we have seen downgrades. If that continues, we will run into a problem". 

While it will be crucial for the governing coalition to maintain its public commitment to reform so that economic confidence can be sustained and stronger growth brings down the deficit, Janeba said he is hopeful, noting the positively surprising consensus reached on all key elements of Germany's pension reform plan. (See MNI INTERVIEW: German Pensions Model For EU Reform - Rocholl)

"That might give the government a little bit of a new push to act in other dimensions, such as tackling the challenges of population ageing and high energy prices,” Janeba said. "The problem is the still very low growth rate of the German economy. Tax revenues will not increase much in coming years, according to the latest official projections, and in the medium run you need to finance [spending] by higher taxes or by cuts in other spending."

ADJUSTMENT POSTPONED

The coalition government has delayed the question of where to find money for its spending increases until after the next election which has to be held by early 2029.

"The major adjustment is only postponed. Whereas we have increases of spending of around 6% this year and the next two years, the plan is to constrain spending in 2029, so that is shifting the problem to the next government." 

The roots of the growth problem lie in Germany's failure to transition from the core sectors of its traditional economic model, such as autos, machine tools and chemicals, and into more innovative and more productive growth sectors, such as aerospace and AI. 

"It's not happening. We see increases in service sector activity, such as healthcare, but this is not where the high productivity growth that Germany needs is going to happen. We see a decline in economic activity in core sectors but no shift towards innovative sectors - that enjoy higher growth,” Janeba said.

Defence to some extent can help absorb workers and resources released by ailing industries and could bring spillovers too, although those will take time to emerge, he said. 

"You have to focus on other industries and that is more about industries being held back by excessive bureaucracy, high social security costs and labour market regulation." 

There is no shortage of promising and dynamic start-ups in Germany but scaling up is tough them, largely due to Germany and Europe's lack of adequate access to risk capital.  (See MNI: Eurozone To Urge Slightly More Fiscal Expansion - Sources)

MNI INTERVIEW2: Yuan To Rise Against Euro Amid Forex Tensions

The yuan is likely to appreciate moderately against the euro in the second half of the year, as exchange rates remain a focal point of China-EU trade frictions, but to fluctuate within a band against the greenback, a leading Chinese economist told MNI in an interview, in which he said Beijing should be alert to a possible joint U.S.-EU push for a stronger yuan.

"In the period ahead, the yuan-dollar pair is likely to remain range-bound, but the RMB's basket effective exchange rate may continue to see very modest appreciation,” Zhang Ming, deputy director of the Institute of World Economics and Politics at Chinese Academy of Social Sciences, said in an interview.

The yuan should fluctuate within a band of 6.60–7.0 to the dollar in the second half, with limited room for further appreciation from the current 6.80, Zhang said, adding that the yuan’s strength against the greenback since last year has been primarily driven by a weaker dollar index. DXY is likely to move between 97 to 103, while the RMB China Foreign Exchange Trade System index of a basket of currencies should move within the 99–104 range, he said. (See MNI INTERVIEW: Yuan In Steady Upward Trend - Sheng Songcheng)

Foreign-exchange settlement by Chinese exporters is also likely to slow down in H2 as the pace of yuan appreciation against the dollar moderates, Zhang said.

MERZ

German Chancellor Friedrich Merz said last month that the yuan's real effective exchange rate has been undervalued by the 30%, but Zhang said this is not the case, pointing to China’s capital account deficit in 2025 of USD820 billion, which is larger than the current account surplus of USD735 billion in 2025.

“It is hard to say a currency is severely undervalued when its country’s current account surplus is smaller than its capital account deficit,” Zhang said.

Still, he saw a possibility that the U.S. and Europe could reach agreement on a joint approach to pressuring Beijing to strengthen the yuan.

Any imaginable yuan appreciation would do little to narrow China’s trade surplus, Zhang said. Even a 10% strengthening against the euro would not diminish the country’s competitive advantage, he said, adding that Europe should instead relax restrictions on Chinese investments in Europe, or increase currently-restricted exports of high-tech goods to China.(See MNI INTERVIEW: New Restrictions To Hit China Investment In EU)

While China’s current account surplus pushes the currency higher, the non-reserve financial account is in deficit, Zhang noted. In the first quarter of 2026, China's current account surplus stood at USD184.1 billion, while the non-reserve financial account deficit reached USD136.1 billion.

Though the yuan has recently stabilised at around 6.80 to the dollar, the CFETS index rose to 102.65 last week, the highest since July 2022. The dollar accounts for approximately 18.3% of the CFETs basket, the euro 17.9% and the yen 8.1%.