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MNI US IG Credit Weekly - Inflation and AI Battle it Out
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Italian Prime Minister Giorgia Meloni’s flagship plans to lower income tax for middle-earners and extend the 15% flat tax for the self-employed to those making up to EUR100,000 a year will depend on the outcome of negotiations with Brussels over more flexibility for an exemption to Europe’s fiscal rules to cover expenditure related to higher energy costs, Italian government sources told MNI.
Italy’s Draft Budgetary Plan (DBP) submitted to the European Commission on Thursday does not provide enough resources to fund either the extension in the flat tax from the current EUR85,000 limit or an increase in the threshold for the 33% rate on income tax to EUR 60,000 a year, one source said, pointing to figures in the official document.
But Meloni and her allies need to deliver on their promises to reduce Italy’s tax burden in their last budget law before the 2027 general election, though without jeopardising the fiscal consolidation achieved in recent years, sources said.
“It would be like being almost at your house or car payment loan after many sacrifices and not to pay just because you can’t go out for dinner,” one source close to Finance Minister Giancarlo Giorgetti told MNI. (See MNI INTERVIEW: ECB Should Halt QT - Bini Smaghi)
FLEXIBILITY
Italy is negotiating three separate issues with the European Commission which could affect its fiscal room for manoeuvre.
The first is exiting the Excessive Deficit Procedure once it is confirmed that the country will close 2026 with a fiscal deficit below 3% of GDP. This is usually confirmed by March, but Italian officials believe the decision could come a few weeks earlier. Leaving the EDP would allow Italy to spend EUR29 billion on defence and energy investments in 2027-28, with around EUR14 billion allocated to each.
The second request, on which Italy is more optimistic, according to sources, is to use part of the additional spending allowed for funding long-term investment in energy infrastructure under the National Escape Clause to Europe’s fiscal rules for measures included in the draft budget.to lower energy prices for households and businesses.
This would allow Italy to use the additional fiscal room to spend more on tax cuts for the middle class, one source said. The DBP allocates EUR2.2 billion to “fiscal measures”, but this would not be enough to fund the nearly EUR3 billion cost of extending the income tax bracket, the source added.
Oct-16 12:54
Rising bond yields should not deter the Bank of England from raising rates, and any dovish shift due to shifting yields might be perceived as akin to fiscal dominance, former Monetary Policy Committee member Michael Saunders told MNI.
In addition to an inflationary impulse from the Iran war, the economy's faster-than-expected growth may reflect early signs of a boost to output from AI, Saunders said, adding that market pricing for a widely-expected BOE hike in November followed by three further hikes is not necessarily exaggerated.
A dovish turn in response to a shift in gilt yields primarily driven by concerns over the UK’s fiscal position would be dangerous, he said.
"If yields go up because of lots of government debt issuance, and you, as the policy maker, respond to that rise in yields by being more dovish, then markets will say, ‘Oh, so you're ... giving governments a green light to be loose fiscally? In that case, all our worries about long-term unsustainable fiscal trends appear more valid,’" said Saunders, now at Oxford Economics.
As a result "inflation expectations will be higher, and the outcome is that life for the central bank will be worse, not better,” he said.
WHAT DRIVES YIELDS HIGHER MATTERS
Saunders pointed to a 2006 speech by Ben Bernanke in which the former Fed Chairman stressed that the monetary policy response to changes in yields should vary according to what drives them. Bernanke’s framework suggests that while a central bank could reasonably compensate for rising term premia with easier policy, a jump in yields driven by inflationary expectations should be met with tighter policy. Saunders, however, cautioned against looser policy to offset higher premia.
Monetary policy concessions to fiscal concerns could be viewed as adjacent to fiscal dominance "and that's just a bad position for a central bank to be in. So if you think risk premium is due to either unsustainable long-term fiscal trends ... or heavy public debt, issuance, I would say the response of the central bank to either of those can't be dovish," Saunders said.
However, he noted that the BOE's decision in September to slow the pace of its gilt sales and to retain a substantial portion of its holdings to back the currency was not, contrary to some speculation, a response to the rise in yields. (See MNI INTERVIEW: BOE Has Scope To Retain More Gilts- Fisher)
"They took the decision to do this several months ago, rather than just in response to rising yields in the last month or two," he said, noting that recently-published minutes of the Bank of England’s July Court meeting, showed the Court then being briefed on the changes. (See MNI INTERVIEW: BOE MPC Shouldn't Lead QT - ex-MPC's Saunders)
Current hawkish markets rate pricing is plausible, he noted.
If energy prices stay high in line with the adverse scenario from the August Monetary Policy Report, "then the market yield curve doesn't look excessive, because the risk of second-round effects would be greater due to a larger and more persistent energy price shock, and the central bank would have to lean against them," Saunders said.
BAILEY'S TIGHTENING CALCULATIONS
While BOE Governor Andrew Bailey has argued that leaving policy on hold in the wake of the outbreak of the Iran war has been roughly equivalent to 75 basis points of tightening, since 75bp of easing had previously been priced in before the conflict began at the end of February, Saunders said that more tightening is needed.
“If you think you need to do more than 75 basis points versus your pre-war expectation, then you need to hike the policy rate outright, and that's where we are now," he said, noting that Bailey’s reckoning did not account for the loss of “the signalling effect of announcing a higher policy rate, which is surely worth something.”
The BOE must also factor in unexpectedly strong recent UK growth data, which Saunders considers may be showing the first signs of a boost from AI.
AI may be "adding materially to overall output growth in the last quarter or two ..It's the sectors which are involved in using AI very directly, as opposed to … [those] for which AI may be an input but isn't yet revolutionising productivity, " he said. (See MNI POLICY: BOE Explores Patchy UK Productivity Gains From AI)
Oct-16 12:11
The Federal Reserve will have to raise interest rates quite a bit further in order to make monetary policy restrictive enough to bring down a stubbornly high rate of inflation, former Richmond Fed President Jeffrey Lacker told MNI.
“The indicators, based on historical relationships, suggest that the rate needs to be closer to 5% to get inflation down,” Lacker said in an interview.
“If you look at Taylor rules of various sorts, I don’t hang my hat on any one particular rule but if you look at a broad range of them, four-and-a-half to five-and-a-half is where they say we ought to be.”
That’s partly because rapid economic growth is lifting the neutral rate of interest, he said.
“The acceleration in current demand certainly suggests that you're going to need higher real interest rates in order to induce the balance for current resources that you need to keep inflation under control,” said the former FOMC member.
URGENCY
Lacker said there is a disconnect between the Fed’s statement that September’s increase in the fed funds rate to 3.75-4% would support a “timelier” return to the 2% inflation target, and communications by top Fed officials signaling a lack of urgency in tightening policy.
“I’m surprised at the lack of urgency they feel about getting inflation down,” he said. “It's been three or four years now where inflation has been predicted by them to return to 2% within a year, a year-and-a-half and it's remained at three or three-and-a-half,” he said. “The longer that happens, the story that we just had some bad luck and some adverse supply shocks each time, strains credulity.”
The September CPI report released this week showed a 3.7% rise in headline inflation and a 2.6% annual gain in core. A monthly rise of 0.3% in core reignited bets on an October hike after officials downplayed the need for such a move. (See MNI POLICY: Fed In No Hurry But Committed To Taming Inflation)
“Core inflation has been firming this year. And what’s more, you’ve got nominal GDP, nominal spending, that’s been accelerating this year.”
AI INFLATION
Strong demand for products and services linked to the AI boom have created a fresh inflationary risk, but one that is squarely within the Fed’s remit and control, said Lacker.
“Uncounteracted, unmanaged, the AI boom is going to be an inflation problem. But it doesn’t have to be. The right response to a large increase in investment demand is for real interest rates to rise to get other sectors to restrain their spending to make room for it,” he said. (See MNI POLICY: AI Buildout Emerges As Top Inflation Risk For Fed)
BALANCE SHEET
Asked about Fed Chairman Kevin Warsh’s five task forces, Lacker said he hopes the one looking at balance sheet policy counsels the central bank to be less interventionist in money markets, which might allow the Fed to shrink its asset base significantly.
“I’m hoping that the balance sheet task force encourages the Fed, induces the Fed, to rethink its aversion to money market volatility and money market spreads,” said Lacker.
“The Fed’s skittishness about repo market volatility is a new thing and I think that’s what drove them to stop running off the balance sheet last year. It kind of has a look of paranoia at this point.”
Oct-16 09:40
Risks the Reserve Bank of Australia will hike the cash rate again this year from its current 4.6% remain skewed to the upside despite September’s weak labour market data, with a former RBA economist warning the figures may be distorted by the Australian Bureau of Statistics’ modernisation of its data collection methods.
“We always talk about looking through seasonality around the end of the calendar year, and I think this could be a case of looking at the trend numbers now, or even the [non-seasonally-adjusted] numbers,” said Blair Chapman, senior economist at SEEK and a former RBA research economist, pointing to the 10-basis-point rise in September's unemployment rate to 4.7%, above the 4.6% consensus forecast, and the 39,000 decline in employment versus expectations for a 20,000 increase.
The sharp swings in employment over the past two months suggest the data may be volatile, he added. “When you take a step back and look at it, movements over the last couple of months, it's a bit softer, but it's not as obvious that there's a massive deterioration. It looks a lot more orderly when you do that,” he said.
The ABS has warned that its modernisation could affect the data, Chapman added, pointing to similar major changes made to the labour force survey in 2014 that altered seasonal patterns for several years. The RBA is likely communicating with the ABS to understand the effects of the changes better, giving policymakers more insight than the market, Chapman added. Unless inflation eases significantly, however, the weaker labour market data is likely to have only a marginal bearing on the Board’s November decision, he argued.
KNEE JERK REACTION
RBA-dated overnight index swaps fell 4-8bp across meetings following the labour force release, with markets now pricing in a 16% chance of a hike at the Nov 3 meeting.
Chapman said the market reaction was overdone, adding that he would still put the probability of a November hike above 50%, and noting that trend unemployment remained steady at 4.6%. “I think it's definitely a bit of a knee-jerk,” he said, arguing that markets had focused on the results without fully accounting for the ABS’s warning.
The labour market may also be showing signs of stabilisation, with job advertisements turning higher over the past month or two. Stronger seasonal hiring for tourism and other industries ahead of Christmas could support employment in the coming months, Chapman noted.
A hike in November when the RBA, will release its Statement on Monetary Policy alongside the meeting, is more likely than a December move, he continued.
The RBA has faced criticism for being behind the curve on inflation, Chapman noted, and delaying a hike until December could reinforce that perception. The Bank will also have opportunities to communicate its policy outlook before the November meeting, making its public messaging worth watching, he concluded.
Oct-15 22:25
Trump administration officials are counting on robust growth driven by AI productivity to boost the U.S. economy’s potential and its long-run capacity to service debt, downplaying fiscal sustainability concerns from the IMF this week and showing no sign of any course correction on debt policy, MNI understands.
The president has said oil prices will fall "precipitously" once the U.S. wins its war with Iran, and the administration is hopeful that 10-year Treasury yields could dip back below 4% once the conflict ends, considering that heavy corporate AI issuance is the primary factor keeping them elevated today.
Trump and his top economic stewards have called on the Federal Reserve to lower rates, arguing the central bank is making a policy error by raising borrowing costs and mistaking supply-side growth for demand-side overheating. Officials remain hopeful that the Fed will listen.
SEPTEMBER CPI
A hot September CPI report did little to take the pressure off the Fed to continue rate increases after a quarter-point hike in September, but the White House is highlighting more subdued underlying price pressures and anchored inflation expectations.
Headline CPI climbed 3.7% while core rose 2.6% -- much lower than the equivalent PCE reading of 3.0%. At the same time, the Fed's alternative measures of underlying inflation run in a 2%-2.5% range and officials at both the central bank and the Trump administration see long-run inflation expectations as having stayed anchored. Traders moved to price about a 50% chance of a hike at the Oct 28 FOMC meeting, up from under 20%, after core CPI rose 0.33% on the month.
Treasury Secretary Scott Bessent sees AI-driven investment raising potential growth to 3% and the supply-side gains as ultimately disinflationary, drawing a parallel with the 1990s when then Fed Chairman Alan Greenspan declined to tighten into a tech boom. Current Fed Chair Kevin Warsh is "well aware" of the productivity gains, Bessent said last month.
IMF Managing Director Kristalina Georgieva said Wednesday the U.S. cannot grow its way out of unsustainably high debt without reducing government spending and cutting deficits, a message echoed by Congressional Budget Office director Phillip Swagel. (See MNI INTERVIEW: Yield Jump, AI Bust Are Top Financial Risks-IMF)
Swagel is due to discuss the U.S. economic and budget outlook with MNI in a webcast on Oct 22. See INVITE: MNI Connect Livestream VC w/ CBO Phillip Swagel Oct 22.
Oct-15 15:57
Canada's central bank is prepared to start raising interest rates as soon as its Oct 28 meeting to prevent high energy prices from turning into sticky inflation, an ex finance official from the country's largest province told MNI.
"By January you'll see rates in Canada policy rates half point higher. Not the start of a tightening cycle, but return to a neutral stance," according to Tony Stillo, who was an Ontario forecasting manager and is now with Oxford Economics.
Monday's inflation report and the Bank of Canada's quarterly business and consumer surveys will be influential in the final decision, he said. That data is weightier than the last job report showing a drop in hiring he said, because it was led by education figures that have been irregular in the past.
Governor Tiff Macklem's policy rate of 2.25% is half a point less than staff estimates of the neutral rate at a time when headline inflation has returned to a 3% pace. Those price gains are at the top of the Bank's target band and Macklem recently told MNI he must keep the inflation goal in focus even if the public is upset by any tradeoffs during a time of uneven economic growth. (See MNI INTERVIEW: Macklem-BOC Faces Tough Calls Ahead On Rates)
Recent concerns about diesel supplies add to risks Macklem has identified of inflation spreading beyond high energy costs as the Iran conflict continues, Stillo said.
MODEST TIGHTENING
"That's the concern that I think the Bank is going to talk to, and say if it's sustained for longer they're worried about the persistence of that leading to more likelihood of pas-through to other core parts of the consumer basket," he said.
The Bank will hike further to 3.75% next year if Stillo's baseline prediction of fading energy prices isn't realized. "We could see the Bank moving to the top of the neutral range and perhaps higher. But we think that's less likely than just repositioning us to a neutral stance," he said.
Recent Fed and ECB hikes aren't a direct reason for Macklem to follow suit, he said. But with the U.S. policy rate as much as 175bp higher than the Bank's, Stillo said further divergence brings Canada's dollar into play as another inflation source. "If they don't raise rates, you'd have a weaker Canadian currency, which could lead to higher import prices," he said.
The Canadian dollar is trading near a 19-month low of about CAD1.42 as of Thursday morning Ottawa time. It's been resilient to U.S. tariffs so far, down just 1% over the last year.
Rate hikes will be modest rather than the jump seen following the pandemic because of a sluggish job market, last month's new round of U.S. tariffs, and population growth slowed by cuts to student and worker visas, Stillo said. "Slack in the economy and the labor market probably lessens the likelihood of a pass through that would be a problem," Stillo said. (See MNI INTERVIEW: Canada Investment Gloom To Outlast Trade Peace)
Oct-15 14:48
You are invited to listen to a livestreamed MNI Connect Video Conference with the Congressional Budget Office, Phillip Swagel.
Details below:
- Speaker: Phillip Swagel, Director of the Congressional Budget Office.
- Topic of discussion: ‘The U.S. Budget and Economic Outlook’
- Date: Thursday, 22nd October 2026, 10 am to 11:30 am ET / 3 pm to 4:30 pm London time.
- This event will be run as a Zoom Webinar and is a public, on-the-record event.
To register please go to: MNI Webcast Registration
Chinese authorities are likely to cut a key preferential mortgage rate in their bid to support property sales further, as recent stimulus measures remain insufficient to deliver broad-based recovery, advisors and analysts told MNI, warning 2026’s decline in real-estate investment could deepen beyond the near 20% drop recorded in the first eight months.
“There is room for a 0.5 percentage point reduction in housing provident fund loan rates, with the timing dependent on the sustained impact of recent policies,” said Xie Yifeng, dean of the China Urban Real Estate Research Institute, who expects the cut by year-end or in the first half of 2027.
China's property market staged a modest recovery during October’s week-long National Day holiday, but the rebound remains uneven, with transactions concentrated in core districts of major cities and the established housing market, Xie added.
However, a further cut to provident fund loan rates would provide broader support for housing demand, Xie continued, noting most homes in major cities failed to qualify for the interest subsidy introduced in late September. The programme only covers eligible first-time buyers purchasing homes valued below CNY1.5 million, up to 120 square metres, with the maximum loan amount capped at CNY1 million per borrower.
The central bank lowered housing provident fund loan rates by 25 basis points in May 2025, bringing interest for first-time homebuyers to 2.1% for terms of five years or less and 2.6% for longer maturities. Commercial mortgage rates stand at about 3%, although the 1 pp interest subsidy has effectively lowered borrowing costs for eligible buyers to around the risk-free rate.
SALES REBOUND
New home sales across 25 major cities totaled 551,000 square metres during the National Day holiday, with average daily sales rising 33.8% y/y, according to data from the China Index Academy (CIA). Average daily second-hand home transactions across 11 major cities jumped 42.8% y/y.
Xie said cities with remaining home purchase restrictions could ease them further, while local authorities may introduce tax cuts, targeted homebuying subsidies for skilled workers and home upgrades, and additional financing to support urban renewal and accelerate purchases of unsold homes.
Beyond a potential rate cut, local governments are likely to broaden eligible uses of housing provident fund withdrawals and raise loan limits, said CIA Analyst Guo Xinyu.
However, Yan Yuejin, vice president of the E-House China Research and Development Institute, urged caution over cutting housing provident fund loan rates, particularly against the backdrop of U.S. interest rate hikes. Increased use of provident fund loans could crowd out commercial bank lending and undermine the effectiveness of mortgage interest subsidies, said Yan, who sees limited prospects for a near-term cut.
END OF PRE-SALES
China's property investment could fall by more than 20% y/y this year as developers adjust land purchases and capital allocation following a late-August policy overhaul requiring them to complete homes before selling them, rather than relying on pre-sales to finance construction, Xie predicted, noting investment had already fallen 19.9% in the first eight months of the year. (See MNI: China's Investment Likely To Decline In 2026 - Advisors)
Despite transitional arrangements, tighter pre-sale requirements will begin to weigh on new housing supply in the fourth quarter and into next year, while increasing pressure on developers to recover capital, Yan said, calling for greater financing support, particularly development loans.
“Only when home sale proceeds truly stabilise will developers be willing to acquire land and commence construction under the new model,” said Lu Donghong, associate research fellow at the Chongyang Institute for Financial Studies, who expects the market to reach an inflection point no earlier than the second half of 2027, or possibly in 2028.
Oct-15 06:00
The Bank of Japan is expected to state underlying CPI inflation has nearly reached 2% at the Oct 29-30 policy meeting, but will fall short of declaring the target met, MNI understands.
While the Bank wants to anchor or stabilise underlying CPI inflation at around 2%, it will take sometime for officials to confirm the achievement and policymakers will likely present forecasts showing the rate moving around 2% after rising above the target in the second half of this fiscal year. The Bank rarely declares the achievement of its goals, preferring to focus on the outlook and to clarify economic, and price conditions.
MNI reported earlier this month that Governor Kazuo Ueda also wants to avoid any acknowledgement that inflation is above target to avert potential criticism from Prime Minister Sanae Takaichi ahead of key appointments to the BOJ board. (See MNI POLICY: BOJ's Ueda Coy On Inflation To Keep PM On Side)
ELEVATED PRICES
High prices continue to impact Japanese consumers, which will also make a declaration of victory by the Bank problematic despite some market players speculating an acknowledgement could occur as early as October
High import prices led by the weak yen and the rise in crude oil costs has driven recent inflationary pressure. However, policymakers believe the economic recovery and a more balanced output gap will ensure it achieves the inflation target.
Crude oil prices are higher than when the Bank last updated its medium-term economic growth and inflation forecasts in July, which will likely prompt the bank to raise its core CPI outlook for this fiscal year from its previous 2.4% prediction.
Oct-15 04:51
Canada’s government is in danger of heading for a repeat of its 1990s fiscal crisis and officials are underplaying dangers of a global yield surge, extra pressure on the central bank to tighten, and scarce room to tackle another downturn, former Finance Canada and Bank of Canada adviser Chris Ragan told MNI.
Federal and provincial governments have time to stabilize things but they must get over a sense of complacency, Ragan said. Today no federal party advocates a balanced budget -- there hasn't been one since 2008 -- and Prime Minister Mark Carney instead touts Canada's triple-A credit ratings and low debt-to-GDP versus G7 peers.
“But it's also true that we're 20 points higher than we were just before the financial crisis, and we're not right there, but we are approaching that danger zone of what we experienced in 1995," Ragan said. "I don't think it's just relative to other G7 countries that matters.”
Debts of federal and provincial governments are 74% of gross domestic product, Ragan estimates, up from about 50% before the 2008 global financial crisis. Canada faces "forced austerity" if that ratio approaches 95% he said, adding that if the present trajectory is maintained it is on course to reach the 99% seen in the 1990s.
YIELD LIFT
Federal bond yields are closely linked with Treasuries and that creates further risk, Ragan said. "We don't know whether the U.S. will turn around their ship. I kind of don't think so anytime soon.”
The 10-year bond yield has climbed about 50 basis points this year versus 115bp for a similar U.S. Treasury, increases that could become more costly if investors shun G7 bonds, Ragan said. (See: MNI: Canada Studied Vulnerability To Fiscal Risk Premium)
Carney has pledged to shrink only the deficit as a percentage of GDP and to balance the operating budget in the next few years while running deficits for military equipment and infrastructure. The power of a fiscal anchor is willingness to stick with it Ragan said, but so far officials are gambling solid growth and low interest rates will do the hard work.
MONETARY SQUEEZE
Higher spending will pressure the Bank of Canada towards higher interest rates, Ragan said. “High government debt complicates monetary policy, even if there's nothing nefarious coming from the government, even if there's no challenge to the independence of the central bank," he said. "The higher government debt becomes, the more bondholders come to expect that maybe inflation will be used.”
It's unlikely Carney -- a former BOC chief -- will directly put pressure Governor Tiff Macklem as Donald Trump has on the Federal Reserve, Ragan said.
“I am cautiously optimistic that the Bank of Canada will in fact maintain its commitment to 2% inflation, and that the government won't engineer with that. But the truth is, we don't know,” he said. (See: MNI INTERVIEW: Macklem-BOC Faces Tough Calls Ahead On Rates)
“If they are doing a whole bunch of new net spending, and they clearly are, then that is pushing up aggregate demand and other things being equal that means central banks are going to have to raise interest rates to keep inflation on target.”
THE EASY PATH
There's room to cut spending, but the options are unpopular even if Carney's economic background makes him a strong candidate to maintain public support, Ragan said. Raising taxes should be avoided because Canada is seeking to lure investment and skilled workers, and a higher federal sales tax is a political non-starter, he said.
Elderly benefits are a good candidate for austerity because it's one of the most expensive budget items and some payouts go to rich households, he said. Military spending will probably rise by CAD100 billion in the next few years, and there's no sign yet of offsetting cuts, Ragan said.
“They are taking the easy path because they know they can much more easily put this on the credit card than they can to raise taxes or cut other spending.”
Oct-14 15:13About
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