MNI INTERVIEW: ECB Cautious On Conflicting Pressures - Gerlach

The European Central Bank wants more evidence on the inflationary consequences of higher energy prices before taking further action, a former central bank official told MNI, after the ECB left rates on hold on Thursday.

Despite eurozone headline inflation rising to 3.8% in September from 3.2% in August, almost entirely because of energy prices, non-energy inflation "has remained remarkably stable at 2.2–2.4% throughout the year. So far, second-round effects have been limited," said Stefan Gerlach, Central Bank of Ireland deputy governor until 2015 and now chief economist at EFG Bank.

However, he said price increases may simply have been delayed.

"Firms appear to have absorbed part of the increase in energy costs through lower profit margins. If energy prices remain high, firms will seek to restore margins by raising prices, spreading inflationary pressures to other goods and services."

HIGHER YIELDS

On the other hand, long-term bond yields have risen considerably across the euro area, particularly in France, and "higher borrowing costs will weaken economic activity and dampen inflation, reducing the need for further rate increases,” Gerlach said.

With uncertainty about French fiscal policy weighing on business and consumer confidence, weakening demand, further ECB rate increases "would heighten concerns about the sustainability of French public debt," he said. "Both considerations strengthen the case for caution.” (See MNI SOURCES: Bond Selloff, France, Clouds ECB Dec Rate Call )

December's meeting, with new economic projections including the outlook for 2029, will be crucial, he said. "The ECB must assess whether delayed pass-through from energy prices will sustain inflation or whether higher borrowing costs will offset those pressures." (See MNI SOURCES: ECB Likely To Wait Till December Before Next Hike)

MNI INTERVIEW 2: Budget Broadly Neutral For BOE- OBR's Miles

Wednesday’s UK Budget has broadly neutral implications for monetary policy, top Office for Budget Responsibility official and former Bank of England Monetary Policy Committee member David Miles told MNI, noting that while measures such as temporary energy tax relief would ease inflation in the first part of next year the effect soon unwinds.

"The Budget is somewhat expansionary in the short-term, and more contractionary a bit further ahead, at least relative to where we were in March," with public sector net borrowing in 2030/31 and 2031/32 "pretty much where it was back in March before we got the oil price [rise] and a new chancellor and a new prime minister," he said.

While there is a bit more fiscal expansion short term and a "bit more fiscal contraction in the second half of the five-year forecast horizon is that big enough for the Bank of England to say 'well there's been a substantial boost to demand in the short run'? I don't think the numbers are big enough to warrant that," Miles said. (See MNI INTERVIEW: UK Wage Growth To Slow - OBR's Miles)

BACKLOADING

One frequent criticism of the government's policy is that pushing fiscal tightening back into the latter years of the forecast makes it unbelievable, as this would be unlikely to be delivered in the run-up to an election due by 2029 at latest. But Miles said this was not necessarily so. 

"Fiscal tightening in expenditure on the scale that's in the central forecast doesn't look beyond the ability of governments, with some determination to stick to the plans, to deliver," he said.

"I wouldn't want to give the impression that because it's a slightly weaker path of bringing borrowing to GDP down in the near term, and it's a little bit backloaded, that that necessarily means this is not credible." he said.

PRODUCTIVITY AND AI

The OBR has in the past come under fire for its relatively upbeat view on productivity growth compared to the BOE and others, but recently-revised official data has now pushed UK productivity back up into line with that of other advanced economies. There are even suggestions the OBR's current forecast, with potential output at 1.25%, should be raised, and Miles said that this would be reviewed in the summer.

"We haven't seen anything yet that makes us deviate from our view that annual productivity (gains) might be something like 0.2, maybe a bit more," Miles said.

"It's somewhat ironic having been told for nearly all the time I've been involved … that the OBR is catastrophically and ludicrously optimistic about productivity to have a change in the estimate of what's happened over that period, which makes our forecast look rather considerably less on the ludicrously optimistic side, and the response of some people is really 'oh well you're wrong again so you're going to have to change it'," Miles said. "I prefer to think ... 'well we've been less wrong so why should we change it'?"

MNI INTERVIEW: UK Wage Growth To Slow - OBR's Miles

Falling job vacancies and a squeeze on firms’ return on capital look set to limit UK wage growth in 2027 despite inflation rising to around 4%, David Miles, a top Office for Budget Responsibility official and two-term former Bank of England Monetary Policy Committee member told MNI.

Miles sees a lower probability of second-round inflation effects driving up wages, which has been cited as a risk by some MPC members, though he considered market expectations of a higher policy rate may be justified as inflation heads up to around 4% on the back of energy prices and with the neutral rate possibly back around its historic average.

In its forecasts accompanying the government’s Oct 28 budget, the OBR predicted average weekly earnings growth of 3.0% in 2027 and just 2.2% in 2028, down from 3.7% this year, figures  only marginally above its projections made before the Iran war shock. (See MNI INTERVIEW: Central Banks Underplay Oil Risk- Baumeister)

"Wage settlements, certainly in the first part of next year, don't look like they're likely to match the rate of inflation, which we think gets to about 4% in the early part of next year," Miles said.

"One of the reasons is that there are ongoing signs of a labour market that's cooling, and they show up more in vacancies, I think, than they do in measures of unemployment or employment.”

The downward trend in vacancies is likely to carry on, he said.

HIRING WEAKNESS

"There's particular weakness in new hiring rather than job moves, and I think that's a factor in giving firms more ability to hold the line on wages."

Another reason firms will not want to give ground on wages is that the OBR estimates that there has been a decline in the real rate of return on corporate capital, a measure of business sector profitability.

"It's a number that used to hover somewhere, for most of the last 20 years, between 12,13% ... We think it's down to not much more than 10 at the moment ...  at the same time as the cost of capital has almost certainly gone up," as nominal and real interest rates have risen, Miles said.

"That's another reason why, in the private sector at least, we think there's going to be a bit of pushback against any attempt to increase wages by an amount that keeps significantly ahead of the actual inflation rate in the near term," he added.

HIGHER BANK RATE

The OBR's forecasts were conditioned on Bank Rate’s rising from 3.75% to just over 4.25% by the middle of next year and to just over 4.5% by the end of its projections.

Miles noted that rates could end up higher if the OBR is wrong about subdued wage growth, prompting firms to raise prices.

He does not believe having Bank Rate in the 4- 5% range is extraordinary or unjustifiable, and is sceptical that the neutral rate of interest has fallen significantly in recent years. 

"What's happened recently to the index-linked bond yields is more dramatic than what's happened to Bank Rate, because a few years ago the yield on 10-year UK government index-linked bonds was minus three, real. It's now plus two," he said, noting that this level of real yield is by no means unusual.

"What was crazy was where we came from, and, in a way, Bank Rate being virtually zero ... was exceptional, extraordinary, and clearly was not going to persist. And I think people, some people seem to still be in the mindset of, 'Oh, a neutral rate should be like two and a half to three'." (See MNI INTERVIEW: UK Needs BOE Hike, Fiscal Squeeze Now - Chadha)

MNI: China Would Consider More EU Export Cap Requests-Advisors

Beijing would be prepared to consider European Union requests to extend a deal for a cap of exports of its hybrid vehicles to other industrial sectors, given the importance of the EU market to China, policy advisors told MNI. 

China and Europe seem to be moving towards a new understanding on trade following successful talks between China’s Commerce Minister Wang Wentao and EU Trade Commissioner Maros Sefcovic in Beijing earlier this month, said Zhao Yongsheng, director of the French Economic Studies Center at the University of International Business and Economics.

China is likely to be prepared to offer further concessions after agreeing the export cap on hybrids, Zhao said, noting that Brussels aims for similar deals over the chemical and machinery sectors. It would also be prepared to boost manufacturing investment in the EU, and to allow more advanced technology transfer, he said, noting that the weakness of China’s domestic demand has enhanced the importance of exports, and of the European market. 

EU officials argue that China’s exports pose an existential threat to European industry, and that it would be in the longer-term interest of both Beijing and Brussels for China to exercise restraint while the EU repairs its lost competitiveness. But while Brussels is, like Beijing, eager to avoid a trade war, it is also considering a tough new trade instrument, with a so-called “kill switch” which would allow it to quickly restrict access to its market.

“This is the EU raising the stakes ahead of the next round of negotiations,” Zhao said. A spokeswoman for China’s Commerce Ministry said on Thursday that China would take countermeasures should Europe impose discriminatory restrictive measures against Chinese products.

CHANGE OF STRATEGY

Tu Xinquan, dean of the China Institute for WTO Studies at the University of International Business and Economics, said Beijing is likely to wait to see how things play out.

“It remains to be seen just how far they intend to expand the quota model, given that the mechanical category is quite broad,” he said, “It is possible for China to make some concessions on certain specific product segments, essentially acquiescing to the implementation of certain import restrictions by the EU.”

“The EU can refine its legislation. For China, the bottom line is that the EU must not impose discriminatory restrictive measures solely targeting China – especially blunt instruments like tariffs,” said Tu, adding that China retains a wide range of countermeasures at its disposal, including restrictions on approvals of rare earth exports. 

Chinese automakers may adjust their strategies to offset the impact of quotas, shifting toward exports of higher-priced hybrid models, Tu said. Meanwhile, China’s shipments of pure electric vehicles could see a corresponding increase next year, as tariffs on such vehicles remain manageable. (See MNI INTERVIEW: Chinese Automakers Eye Gradual EU Production)

He Weiwen, senior fellow at the Center for China and Globalisation, said China still regards the EU as a partner, not a rival. Europe now needs China’s help to strengthen its own industrial competitiveness, via provision of technology and capital, said He, noting how Europe has lagged behind China in developing AI.

However, China would also take firm countermeasures against any actions by the EU that violate WTO rules, He said.

MNI: China Would Consider More EU Export Cap Requests-Advisors

Beijing would be prepared to consider European Union requests to extend a deal for a cap of exports of its hybrid vehicles to other industrial sectors, given the importance of the EU market to China, policy advisors told MNI. 

China and Europe seem to be moving towards a new understanding on trade following successful talks between China’s Commerce Minister Wang Wentao and EU Trade Commissioner Maros Sefcovic in Beijing earlier this month, said Zhao Yongsheng, director of the French Economic Studies Center at the University of International Business and Economics.

China is likely to be prepared to offer further concessions after agreeing the export cap on hybrids, Zhao said, noting that Brussels aims for similar deals over the chemical and machinery sectors. It would also be prepared to boost manufacturing investment in the EU, and to allow more advanced technology transfer, he said, noting that the weakness of China’s domestic demand has enhanced the importance of exports, and of the European market. 

EU officials argue that China’s exports pose an existential threat to European industry, and that it would be in the longer-term interest of both Beijing and Brussels for China to exercise restraint while the EU repairs its lost competitiveness. But while Brussels is, like Beijing, eager to avoid a trade war, it is also considering a tough new trade instrument, with a so-called “kill switch” which would allow it to quickly restrict access to its market.

“This is the EU raising the stakes ahead of the next round of negotiations,” Zhao said. A spokeswoman for China’s Commerce Ministry said on Thursday that China would take countermeasures should Europe impose discriminatory restrictive measures against Chinese products.

CHANGE OF STRATEGY

Tu Xinquan, dean of the China Institute for WTO Studies at the University of International Business and Economics, said Beijing is likely to wait to see how things play out.

“It remains to be seen just how far they intend to expand the quota model, given that the mechanical category is quite broad,” he said, “It is possible for China to make some concessions on certain specific product segments, essentially acquiescing to the implementation of certain import restrictions by the EU.”

“The EU can refine its legislation. For China, the bottom line is that the EU must not impose discriminatory restrictive measures solely targeting China – especially blunt instruments like tariffs,” said Tu, adding that China retains a wide range of countermeasures at its disposal, including restrictions on approvals of rare earth exports. 

Chinese automakers may adjust their strategies to offset the impact of quotas, shifting toward exports of higher-priced hybrid models, Tu said. Meanwhile, China’s shipments of pure electric vehicles could see a corresponding increase next year, as tariffs on such vehicles remain manageable. (See MNI INTERVIEW: Chinese Automakers Eye Gradual EU Production)

He Weiwen, senior fellow at the Center for China and Globalisation, said China still regards the EU as a partner, not a rival. Europe now needs China’s help to strengthen its own industrial competitiveness, via provision of technology and capital, said He, noting how Europe has lagged behind China in developing AI.

However, China would also take firm countermeasures against any actions by the EU that violate WTO rules, He said.

MNI INTERVIEW: Chinese Automakers Eye Gradual EU Production

Chinese automakers are poised to expand local production in Europe over the next decade, up from just 1% in 2025, but the pace will depend on EU efforts to cut regulatory hurdles and improve supply chain competitiveness, a Chinese auto industry expert told MNI.

Cui Dongshu, secretary-general of the China Passenger Car Association (CPCA), said that locally produced vehicles could account for around 25% of Chinese brands' European new energy vehicle sales within five years, rising to about 40% within a decade.

However, for Europe to attract more Chinese automotive investment, policymakers would need to simplify lengthy environmental impact assessments and approval procedures for automotive factories and battery projects, while ensuring greater policy stability, Cui said. He also called for stronger local supplies of critical battery materials such as lithium and cobalt, more integrated battery supply chains and lower production costs.

Europe should expand cooperation on battery technologies rather than create exclusionary barriers, he noted, while harmonising subsidy and tax rules across member states to reduce fragmentation between national markets. "Europe also needs established automotive parts supply chains, logistics networks and access to skilled workers," Cui said. (See MNI INTERVIEW: EU Looks At Options To Boost Competitiveness)

TRADE DEAL

Beijing agreed earlier this month to limit hybrid vehicle exports to the EU to 350,000 units annually, with the quota rising by 6% each year over four years, according to EU officials. The restrictions are expected to take effect in early December. (See MNI EM POLICY: EU Aims To Extend China Hybrids Deal To Chemicals) "The recent EU-China agreement on hybrid vehicles is essentially a quota arrangement designed to ease short-term trade tensions," Cui said. "It will not significantly accelerate localisation."

The quotas would provide Chinese automakers with a temporary window to continue exporting fully assembled vehicles, allowing some manufacturers to postpone investments in European factories, Cui explained. "Some automakers will prioritise making full use of their quotas, delaying their plans to build factories," he said. However, in the long term, pressure from trade barriers will remain and localisation is still the inevitable direction, Cui added.

Chinese automakers including BYD, Chery and Leapmotor have expanded their European manufacturing operations or pursued local assembly partnerships. Great Wall Motor said on Tuesday it would begin manufacturing its Ora 5 electric SUV in Bulgaria in Q1, 2027.

STRUCTURAL IMPACT

Cui said China's plug-in hybrid exports to Europe reached 302,000 vehicles in 2025 and were likely to decline year-on-year in 2026 under the quota mechanism. He estimated that shipments could be 120,000 to 150,000 vehicles lower than under a scenario without quotas.

"The impact will be structural," Cui said. "Leading automakers that secure quotas will see relatively stable orders, while smaller and medium-sized automakers will face significantly reduced export opportunities."

Smaller manufacturers could respond by redirecting exports to other overseas markets or accelerating plans to assemble vehicles locally in Europe, he noted. Cui said the restrictions were unlikely to derail China's broader new energy vehicle export growth, as battery-electric vehicle shipments and demand from other overseas markets could offset some of the pressure. "This will not change the broader upward trend in China's overall new energy vehicle exports," he said.

While China’s export- and AI-related sectors remain buoyant, negative growth in broad fiscal spending has been a major drag, a government advisor recently told MNI. (See MNI EM INTERVIEW: China Advisor Calls For More Public Investment)

MNI FED WATCH: No-Guidance Warsh Collecting Data Before Moving

Federal Reserve Chairman Kevin Warsh said Wednesday the central bank wants to gather more information before deciding on its next policy move despite persistently high inflation. 

The economy has strengthened, the labor market firmed and inflation remains elevated, he said at his post-meeting press conference. The FOMC is seeking further clarity of underlying trends, and the upcoming intermeeting period will contain much new information, he said.   

“It's our responsibility to get inflation down. That's the reason the FOMC's discussion over the last couple of days focused mainly on the price stability side of our remit,” Warsh told reporters. “We have started to see some changes in financial and credit conditions. They have tightened for some businesses and households, much as we would expect." 

Still, Warsh said financial conditions cannot be described as tight. 

“While overall financial conditions are tighter, I'm unwilling and unable to call them tight. But broadly, these developments go in the direction of achieving a longer, more durable period of economic growth and price stability.”

The Fed’s statement offered tidbits for hawks and doves alike. The economy was depicted as “strong,” an upgrade from “solid” in September. At the same time, the committee’s policy statement offered no direct indication that future tightening will be forthcoming. (See: MNI INTERVIEW: Lockhart Sees Next Fed Hikes in Dec, Q1)

The futures market implies an 80% chance the Federal Reserve will raise interest rates in December and traders see about 65 basis points of increases in total through June. 

BULLISH ON ECONOMY

Warsh offered a sanguine view of the economy’s growth prospects, pushing back against the idea that AI is the only thing driving activity. 

"The third quarter appears to have brought an even more rapid advance, led by healthy consumer spending, likely running above 3% growth, and business investment likely rising at about a double-digit pace," he said. 

But Warsh doesn't view this as necessarily inflationary. "Is the economy running too hot? Is the economy running too strong? That isn't the judgment of most of my colleagues."

INTO THE CRACKS

He was also skeptical of the notion that interest rate hikes will have no effect on the AI sector given high levels of capex spending and computing demand more generally. (See: MNI INTERVIEW: Fed Will Hike Later To Keep Up With AI- English)

“Interest rates get in the cracks. Interest rates affect directly or indirectly almost everything,” said Warsh.  

“And what have we seen since early September? What we've seen inside of the technology complex, outside of the technology complex. Interest rates have had an effect. You see market participants that are discriminating between the kinds of investments they want to make. You've seen credit spreads for certain assets widen out, gap out. For others, you've seen some tightening in financial conditions, but not significantly.” 

CALENDAR SHIFTS

As previously hinted, Warsh announced the Fed will be reducing the number of policy decisions out of its eight yearly meetings. One meeting in the fall of 2027 will focus on broader questions regarding Fed thinking and policy frameworks. He expects that in 2028 the Fed will have two meetings dedicated to discussions of strategy and
six for setting policy. 

“Getting policy right involves assessing near-term developments at timely, regular, and information-rich intervals,” said Warsh. “But it's equally important we reserve time and space as an intellectually diverse group for strategic deliberations, for thinking anew about big questions, looking out over longer time horizons, focusing, as I say, on the left side of the decimal point.”