Weekly global economic update

What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.

Ira Kalish

United States

Low fertility rates in advanced economies create challenges

  • One of the biggest long-term challenges facing advanced economies is demographics. Moreover, the long term has arrived. The problem, according to a new report from the Organisation for Economic Co-operation and Development (OECD), is that the average fertility rate in the 38 member countries has more than halved since 1960. In addition, all member countries with the exception of Israel now have fertility rates below the replacement rate. That is, absent immigration, these countries would see declining populations. Some are already experiencing this. The OECD member country with the lowest fertility rate is South Korea (from where I am writing this update).

The OECD said that this situation “will change the face of societies, communities, and families and potentially have large effects on economic growth and prosperity.” Low fertility means that the working-age population will decline as a share of the total, thereby putting pressure on pensions and health care. Low fertility implies slower economic growth absent acceleration in productivity growth. 

One solution to the fertility challenge is immigration. Yet this has become a contentious political issue in many countries. Some opponents of immigration suggest policies meant to encourage families to have more children. In Japan, the government is providing financial incentives. Some pundits suggest that government discourage the use of contraceptives, and some suggest that women stay home and not work. 

Yet the OECD says that fertility rates are higher in countries with greater female labor-force participation. Rather, the OECD urges governments to implement policies meant to encourage equitable sharing of work and parenting. In addition, the OECD suggested policies meant to encourage people to stay in the workforce longer, thereby boosting the ratio of workers to retirees. In part, this would require policies that promote better health. 

The OECD reported that Hungary has successfully boosted its fertility rate through large government spending on childcare. On the other hand, some other countries have seen continued declines in fertility rates despite extensive policies to support families. At the end of the day, it is likely that the optimal solutions are immigration combined with more investment in labor-saving and labor-augmenting technologies meant to boost productivity. Many observers hope that generative AI will play a role in facilitating this increase in productivity. 

Eurozone faces fiscal challenges, due in part to demographics

  • The European Central Bank (ECB) has warned that member countries face “significant fiscal burdens” due to demographics (declining ratios of workers to retirees), higher defense spending, climate-related investments, and higher borrowing costs. The result has been higher than optimal budget deficits leading to high debt levels. The ECB said that, to restore fiscal probity, member states will have to cut their average budget deficits by 5 percentage points of GDP each year.

That is a tall order. In the recent European Parliamentary elections, voters pivoted toward far-right political parties, some of which favor more government spending. In France, where the government called a new Parliamentary election and where the far-right RN Party appears to have a good chance of forming a government, many investors have sold off government bonds on fear of greater fiscal largesse.

One problem is that, even if governments do nothing to change fiscal policy, deficits will likely worsen, if only because of demographics. In many countries, working-age populations are stagnant or declining while elderly populations continue to grow. This implies rising costs of pensions and health care but stagnant tax revenue. The ECB said that, just to stay even, governments will have to cut deficits by 3 percentage points of GDP each year starting now. To get debt levels back toward the ECB’s target of 60% of GDP will require further reductions in deficits.

Not surprisingly, the ECB said that the fiscal problem varies by country. The countries that must attack their deficit most vigorously, according to the ECB, are Slovakia and Spain. The countries with less burdensome challenges are Estonia, Croatia, Greece, and Cyprus. In the case of Greece, it already did the heavy lifting when it dealt with its own debt crisis a decade ago.  

Eurozone labor market remains tight

  • The latest indicators from the European Union (EU) point to continued tightness of the Eurozone labor market and continued rapid increases in labor costs. This suggests that, although the ECB has started the process of cutting rates, its actions will likely be stifled by concerns about the impact of labor costs on inflation. 

First, the EU reports that, in the first quarter of 2024, the job vacancy rate in the Eurozone remained at 2.9%, the same as in the previous quarter. Although the rate has fallen from a peak of 3.4% in the second quarter of 2022, it remains historically high. Consider that, in the fourth quarter of 2019 just prior to the pandemic, the job vacancy rate was 2.3%, quite high compared to the previous decade. It had been 1.5% in the first quarter of 2014. 

Also, the Eurozone countries with the highest job vacancy rates are, in order, Austria (4.5%), Belgium (4.4%), Netherlands (4.4%), and Germany (3.5%). By industry, the highest job vacancy rates are in administration and support services (4.7%), accommodation and food service (4.4%), and construction (3.8%). 

These numbers point to a tight labor market, thereby pushing up wages. Indeed, the EU separately reports that, in the first quarter of 2024, hourly labor costs in the Eurozone were up 5.1% from a year earlier, up from an increase of 3.4% in the fourth quarter of 2023. In seven of the last nine quarters, labor costs were up more than 4% from a year earlier. Thus, despite a significant decline in inflation, labor-cost increases continue to be relatively strong. The first-quarter data included a 5.8% rise in wages and a 4.8%rise in non-wage labor costs. Labor costs rose more rapidly in the service sector than in the industry sector, which is not unexpected.

By country, the year-over-year rise in labor costs was 5.9% in Germany, 2.7% in France, 3.1% in Italy, 4.7% in Spain, 7.8% in the Netherlands, and 2.3% in Belgium. Moreover, within the larger EU, there were especially big labor-cost increases in Eastern Europe. For example, labor costs were up 14.1% in Poland, 16.4% in Romania, 15.2% in Croatia, 15.8% in Bulgaria, 13.7% in Hungary, but only 5.9% in Czechia. These strong increases likely reflect relatively high inflation combined with tightness in labor markets.

Underlying inflation eases in Japan and the United Kingdom

  • In Japan, headline inflation accelerated in May to the highest level since February, largely due to a sharp rise in electricity prices. However, the best measure of underlying inflation (core-core) fell to 2.1%, the lowest level since September 2022. As such, it appears that the Bank of Japan’s (BOJ’s) primary goal is being achieved. This raises questions as to whether the BOJ needs to tighten monetary policy, especially at a time when the economy appears to be stagnant.

Let’s look at the details: In May, consumer prices were up 2.8% from a year earlier, up from 2.5% in April. The acceleration was attributed to a 14.7% increase in electricity prices as subsidies were fully phased out. Prices were up 0.5% from the previous month. When volatile food and energy prices are excluded, so-called core-core prices were up only 2.1% in May versus a year earlier, the lowest since September 2022 and down from 2.4% in April.

The BOJ increased interest rates earlier this year and ended the yield curve control policy that suppressed bond yields. This happened at a time when inflation remained too high while the economy seemed relatively healthy. Now, underlying inflation is roughly at the BOJ’s target while the latest PMIs indicate economic weakening. Thus, it is no longer clear if it makes sense for the BOJ to further tighten monetary policy. Yet uncertainty over the BOJ’s intentions, combined with strong US growth, have contributed to a declining yen (it hit 159 yen to the dollar recently).

  • Inflation in the United Kingdom finally hit the Bank of England’s 2% target, but the details suggest that there is more work to do. Consequently, no one expects the latest inflation report to change the trajectory of BOE policy. Let’s look at the details.

In May, British consumer prices were up 2% from a year earlier, the lowest since July 2021. Prices were up 0.3% from the previous month. When volatile food and energy prices are excluded, core prices were up 3.5% from the previous year, the lowest since October 2021.

Prices of services were up 5.7% from a year earlier. Still, this was better than previously and was the lowest rate of service inflation since July 2022. However, it is unlikely that core (underlying) inflation will hit the 2% target if service prices continue to rise rapidly. The problem with services is that they tend to be labor intensive. The labor market is tight and is generating significant wage gains. A tight monetary policy is meant to weaken the labor market sufficiently to ease wage pressure.

As of this writing, the BOE’s policy committee is less than 24 hours away from a meeting in which it is expected to keep interest rates unchanged. The inflation report, which was lauded by the government, did not suggest a need for a quick easing of monetary policy. On the other hand, an expectation that the BOE will cut rates sometime in the coming months remains—but not before the July election.

US retail sales signal possible consumer slowdown

  • In the United States, retail sales grew slowly in May following negative growth in April. Does this mean that the long-awaited slowdown in consumer spending growth is finally here? Possibly. The government’s retail sales numbers are not adjusted for inflation and include changes in prices as well as volumes sold. In recent months, major retailers have become aggressive in cutting prices to generate sales. This has contributed to the lack of inflation for goods. It also reflects the weakness in demand for goods. A governor of the Federal Reserve, Adriana Kugler, says that these trends make her more optimistic that inflation is quickly moving toward the 2% target. More importantly, she said that “if the economy evolves as I am expecting, it will likely become appropriate to ease policy at some point later this year.”

Kugler based her views, in part, on conversations she has had with major US retailers. She said that “what I have heard in my own conversations with business contacts is that consumers are ‘trading down’ to lower-cost products and that firms are responding with more discounting.” While this is good news for inflation and interest-rate policy, it also suggests the possibility of a weakening of the economy. Kugler added that “we’re watching closely to make sure we’re not surprised by a sudden increase in unemployment. From previous experience, what we have seen is that when these phenomena take root, unemployment [can go] up very, very quickly.” Indeed, unemployment, while still low, has risen significantly in recent months.

In any event, let’s look at the retail sales data: In May, retail sales were up 0.1% from the previous month after having declined 0.2% in April. In part, the decline reflected the impact of declining gasoline prices, causing sales at gasoline stations to fall 2.2%. When this is excluded, retail sales were up 0.3%. On the other hand, retail sales were boosted by a 0.8% increase in sales at automotive dealerships. When this is excluded, retail sales fell 0.1%.

Meanwhile, sales were down sharply at furniture stores and home improvement sales, likely reflecting declining prices as well as a weak home market. Sales were also down at grocery stores. On the other hand, sales grew strongly at clothing stores and non-store retailers. Surprisingly, sales were down at food service establishments.

If underlying consumer demand is weakening, it comes at a time when real (inflation-adjusted) wages are rising while employment is rising. Moreover, energy costs are tame. On the other hand, borrowing costs are high, house prices are rising, and consumer demand for homes is weak. These factors could cause weak spending on home-related goods and services.

G7 leaders focus on China

  • Last week, the leaders of the G7 nations held a summit in Puglia, Italy hosted by Italian Prime Minister Giorgia Meloni. The G7 are the largest economies among advanced democratic nations—the United States, Canada, the United Kingdom, Germany, France, Italy, and Japan. The tradition of G7 summits began 49 years ago in Rambouillet, France when, following the oil crisis of 1974, the advanced democracies chose to attempt to coordinate macroeconomic policy in the face of high inflation, stagnant growth, and geopolitical crisis. Sound familiar? 

In any event, geopolitics was at the core of the discussions, with particular emphasis on China and Russia. The G7 issued a statement saying that China’s non-military support for Russia is a “long-term threat” to European democracy. This augurs for further restrictions on economic interaction between the G7 and China. Even without action by governments, global companies are increasingly wary of geopolitical risk. For example, a large European automaker announced a shift in electric vehicle production from China to Europe. The downward trend of inbound foreign direct investment in China reflects the desire of global companies to reduce exposure to Chinese risk. The United States was especially focused on Russia and Ukraine and US policy toward China.

Notably, former European Central Bank (ECB) President Mario Draghi, long a supporter of market-based policies, said that Europe should be less “passive” in the face of a threat from China. He said that the European Union (EU) should be prepared to use tariffs and subsidies, an unusual position for a leading economist. Specifically, he said that “we do not want to become protectionist in Europe, but we cannot be passive if the actions of others are threatening our prosperity. Even recent US decisions to impose tariffs on China have implications for our economy through the redirection of exports.” He also said that Europe’s challenge is greater than that of the United States because Europe is “more vulnerable both to inaction on trade and to retaliation.” He said that there is “ample evidence that part of China’s progress owes to sizeable cost subsidies, trade protection and demand suppression, and that will lead to lower employment for our economy.” The EU has appointed Draghi to prepare a report on how Europe can restore competitiveness in the face of challenges from both the United States and China. 

Draghi’s views are not universally held among G7 leaders. For example, Germany’s economics minister, Robert Habeck, said that “tariffs are always a last resort as a political tool and are often the worst option.” German industry is especially concerned lest EU restrictions on trade with China invite retaliation that hurts German industry.  

US dollar likely to remain dominant in global economy

  • The world is awash in dollar pessimists. Periodically, some pundits bemoan the declining importance of the dollar and the potential for the dollar to lose its position of global dominance. Indeed, the share of central bank reserves held in dollars has been declining for several years. Yet a new study by the Federal Reserve Bank of New York (FRBNY) suggests that the role of the dollar has not diminished and that demand for dollars remains robust. Moreover, to the extent that central bank holdings of dollar reserves have declined, it is mainly due to a small number of countries. 

First, a few facts. The share of central bank reserves held in US dollar assets fell from roughly 70% in 2000 to about 60% today. Of US$12 trillion in reserves, about US$7 trillion is now held in dollars. No other country’s currency comes close. According to the FRBNY study, a significant share of the decline in the dollar share was due to Switzerland. That is, Switzerland significantly increased the share of its holdings held in euros given that its trade is principally with Eurozone countries. Plus, Swiss monetary policy is sensitive to the franc-euro exchange rate. 

Another important factor in the decline in the dollar share was a decision by Russia to reduce its dollar exposure, perhaps out of fear of new sanctions. The dollar share of Russian reserves fell by 29 percentage points from 2015 to 2021, before the war in Ukraine. Switzerland and Russia together accounted for more than half the decline in the dollar share of global reserves. Almost all the remaining decline was due to China, India, and Turkey. These countries reduced their dollar exposure, with China especially focusing on diversification and increased holdings of gold. This reduces China’s exposure to US sanction risk. Excluding these five countries, the dollar share of central bank reserves was roughly unchanged in the past two decades. 

Meanwhile, the euro share of reserves has been falling, declining by roughly 100 billion euros last year alone, according to the ECB. The decline in the past year was partly due to euro sales by the central banks of Switzerland and Japan. This was an effort to avert currency depreciation against the euro. Plus, the ECB expressed concern that possible EU confiscation of Russian assets to support Ukraine could lead to further Russian sales of euros. 

Finally, the FRBNY study indicated that the global appetite for Chinese renminbi has “soured.” It said that a survey of foreign currency reserve managers at major central banks found that 12% of managers intend to reduce exposure to renminbi. Just two years ago, one-third of managers intended to increase renminbi exposure. The study said that “this is partly due to relative pessimism on the near-term economic outlook in China, but the vast majority also mentioned market transparency and geopolitics as deterrents” to holding renminbi. 

The bottom line is that the US dollar remains, by far, the dominant global currency. Moreover, there is nothing to indicate that this is changing. Thus, what has been called the exorbitant privilege of the United States remains. That is, the United States retains the ability to issue debt in its own currency, thereby not being exposed to currency volatility. Moreover, dollar-denominated assets remain the most liquid and are perceived as the safest, thereby suppressing the cost to the US government of issuing debt. The problem with this privilege is that it reduces the incentive for the US government to implement fiscal discipline. 

ECB cuts rates after prolonged period of tightness

  • Recently, as expected, the ECB cut interest rates for the first time since 2019. The benchmark rates were cut by 25 basis points after a prolonged nine-month period in which rates were at the highest level since the start of the euro. The ECB is tasked with targeting inflation and had kept a tight monetary policy due to the surge in inflation two years ago following the pandemic. Now, with inflation receding and the Eurozone economy remaining weak, the ECB determined that some easing of monetary policy is appropriate. 

On the other hand, the ECB acknowledged that, due to elevated wage growth, price pressures remain strong, especially in the services sector. Thus, the ECB expects inflation to remain above the 2% target for the remainder of this year. This implies that further interest rate cuts will likely be gradual. Indeed, the ECB commented that it “will keep policy rates sufficiently restrictive for as long as necessary.” The ECB expects inflation to average 2.5% this year, 2.2% in 2025, and 1.9% in 2026. 

With its action last week, the ECB now joins several other central banks in cutting rates. These include the Bank of Canada and the Swiss National Bank. Yet two important central banks, the Federal Reserve and the Bank of England, have yet to cut and will likely wait until data confirms that inflation is headed in a favorable direction. Most important, of course, is the Federal Reserve. Its actions have a vast impact on global financial markets. The fact that the ECB moved ahead of the Fed, for the first time ever, indicates that the Fed’s position will likely continue to depress currency values around the world. That, in turn, has the potential to boost inflation. 

Moreover, there is a view that the Fed’s hesitation will limit the scope for interest-rate reductions by the ECB. In fact, it is reported that hedge funds are betting against further cuts by the ECB. That is, they are betting against reductions on European bond yields on the expectation that the ECB will be slow to cut short-term interest rates further. 

US inflation recedes

  • Before the Fed could act, financial markets reacted very favorably to the latest inflation report from the US government. Inflation in May was lower than anticipated, with core inflation hitting a more than three-year low. Prices barely budged from the previous month. The result was that bond yields fell, equity prices rose, the value of the dollar fell, and the futures market’s implied probability of the Federal Reserve cutting interest rates before the US election increased. In fact, the probability of a rate cut before November increased from 60% to 84% recently. However, this was reversed later in the week when the Fed offered a hawkish viewpoint (see below). Let’s look at the details.

In May, the US consumer price index (CPI) was up 3.3% from a year earlier and unchanged from the previous month. The annual figure was roughly within the range seen in the past 12 months. Yet when volatile food and energy prices are excluded, core prices were up 3.4% from a year earlier, the lowest rate since April 2021. Core prices were up 0.2% from the previous month. 

As for volatile energy and food prices, energy prices were up 3.7% in May from a year earlier but were down 2% from the previous month. Food prices were up 2.1% from a year earlier, which included a 1% increase for food eaten at home and a 4% increase for food eaten away from home. The higher inflation for food eaten away from home reflects the labor intensity of the restaurant industry and the fact that, in a tight labor market, wages continue to rise rapidly. 

Meanwhile, the biggest problem remains services, especially the shelter component, which was up 5.4% from a year earlier. Still, this is down substantially over the past year and was the lowest shelter inflation since April 2022. The overall services price index was up 5.2% while services-less shelter was up 5%. On the other hand, prices of durable goods were down 3.8% while prices of non-durable goods were up only 1.8%. Thus, inflation remains a service problem, and not just a shelter problem. And as discussed ad nauseum in previous updates, services are labor-intensive, the labor market is tight, and wages continue to rise too rapidly. 

Finally, it is worth noting the sharp decreases in the prices of some durable goods. For example, prices were down from a year earlier by 9.3% for used cars, 6.2% for major appliances, 3.3% for living room furniture, 5% for outdoor equipment, 6.6% for televisions, 7.8% for toys, 11.5% for smartphones, and 6.6% for computer software. Plus, this is a return to normalcy. Until the recent spate of pandemic-induced inflation, declining prices of durables was typical, reflecting continued sharp rises in the productivity associated with producing such goods. 

Investors interpreted the report as boding well for the Fed to cut rates sooner and possibly faster than previously expected. That depends, of course, on this report not being an outlier, but rather being a continuation of a favorable trend. The S&P500 stock index hit a record high, having risen 1.1% on the inflation news. Plus, the yield on the government’s 10-year bond fell to the lowest level since early April. Non-US central banks likely welcomed this news. Their decision to cut rates before the US Federal Reserve left them exposed to increased capital outflow and, consequently, depreciating currency values. Now, this worry is lessened—at least temporarily. 

US job market remains tight

  • The US government recently reported that employment grew far faster than expected in May. This added to the perception that the Federal Reserve will be hesitant to cut interest rates any time soon. A strong jobs report implies strong wage gains, thereby boosting inflationary pressure. The Fed would likely prefer to see a weaker jobs report. Let’s look at the details.

The US government releases an employment report based on two surveys. First, there is a survey of establishments. Second, a survey of households. The establishment survey indicates that 272,000 new jobs were created in May, the third biggest increase in the past 12 months. This means that, in four of the five months in 2024, employment grew faster than 200,000 per month. This is far faster than the long-term expectation. The industries that saw the most growth in employment included health care, leisure and hospitality, professional services, local government, and construction. 

The establishment survey also included data on wage increases. It found that average hourly earnings for private sector workers were up 4.1% in May versus a year earlier. This was up from 4% in April and the same as in March. Thus, wage growth continues to be faster than inflation, a fact that is likely to be important for the Federal Reserve as it deliberates. Only an increase in labor productivity would allow the Fed to ignore wage gains, and it is unclear if this is happening. 

Finally, the survey of households, which includes data on self-employment, found that there was a decline in labor force participation in May, but an even bigger decline in the number of people reporting being employed. The result was that the unemployment rate increased from 3.9% in April to 4% in May, the highest since January 2022. Still, it is an historically low number and will not likely raise alarm at the Federal Reserve. 

The International Monetary Fund expressed concern about the size and trajectory of the US budget deficit, but investors evidently were not interested. The concern stems from the rising cost of government entitlements for the elderly as well as rising interest costs on government debt. Moreover, there appears to be little or no interest in seriously addressing the issue on the part of either political party. Both parties are offering policy ideas that would likely increase the budget deficit. Yet investors remain content with the attractiveness of US government debt, thereby keeping bond yields relatively low. Moreover, when the Fed eventually begins to cut interest rates, and provided inflation expectations don’t increase, it is likely that bond yields will fall.  

Fed offers hawkish view despite favorable inflation news

  • Recently, after absorbing conflicting data on inflation and jobs, the US Federal Reserve left its benchmark interest rate unchanged, as expected. However, the members of the policy committee surprised investors with their own projections of short-term interest rates. Specifically, the so-called “dot plot,” which is a graph showing the interest rate forecasts of each member of the committee, indicates the median forecast is for only one rate cut in 2024. Until this was released, the futures market implied forecast was for two interest rate cuts in 2024, especially after the favorable inflation report that came out recently. In addition, the members offered a relatively unoptimistic forecast of inflation, despite the favorable inflation reading for May. They increased their median forecast for PCE-deflator inflation in 2024 from 2.4% to 2.6%. Their forecast for core inflation also increased from 2.6% to 2.8%. 

The Fed is evidently taking a more hawkish stance than expected. Fed Chair Powell said that the inflation number was “encouraging” but that the Fed is choosing to be somewhat “conservative.” Moreover, he noted that 15 of the 19 committee members forecast either one or two rate cuts in 2024. He said this means that either option is “plausible.” Thus, investors are left wondering what to expect. Also, four members predicted no rate cut in 2024. 

In response to the Fed’s statements, equity prices initially declined before rebounding while bond yields increased. Plus, the implied probability of a rate cut before November fell from 80% before the Fed’s announcement to 64% now. This is where it was just prior to the release of the inflation report. As such, investor expectations have become volatile. On the other hand, favorable reports on producer prices and initial claims for unemployment insurance recently led investors to push down bond yields, despite what the Fed had indicated.

Moreover, some pundits suggested that, if the Fed is only going to cut once during 2024, why do it in September and then wait a long time before cutting again? Rather, they suggest that a likely scenario is a rate cut in December, thereby allowing the Fed more time to accumulate the necessary data. On the other hand, the decisions of the Fed are more likely to be driven by data than other considerations. If the data moves in the right direction this summer, a September rate cut remains possible.

US household income and spending fall while inflation is steady

  • When adjusted for inflation, US household income and spending fell slightly from May to April, indicating a weaker beginning to the second quarter of 2024. In addition, the Federal Reserve’s favorite measure of inflation remained steady from May to April, indicating that the recent deceleration of inflation might have stopped. Still, both headline and core inflation are below 3%. With the economy possibly weakening, this likely sets the stage for the Fed to start cutting interest rates in September, which is what investors now expect. Let’s look at the details.

In April, real (inflation-adjusted) disposable personal income fell 0.1% from the previous month. This was likely due, in part, to the sharp slowdown in employment growth from March to April. Indeed, payroll employment grew in April at the slowest pace since October 2023. In addition, consumer spending fell 0.1% from March to April, after having grown at a robust pace in both February and March. Income and spending fell at the same rate as the personal savings rate remained steady at 3.6% of disposable income. 

The real decline in consumer spending involved a 0.1% drop in spending on durable goods, a 0.5% drop in spending on non-durable goods, and a 0.1% increase in spending on services. 

Meanwhile, the government also released data on the Federal Reserve’s favorite measure of inflation, the personal consumption expenditure deflator, or PCE-deflator. First, a word about the difference between the PCE-deflator and the more popular consumer price index (CPI). The CPI measures the changing price of a fixed basket of goods and services, reflecting the direct purchases made by households. The PCE-deflator measures the changing price of a basket that changes according to changing patterns of consumer spending. In addition, the PCE-deflator includes spending for households, regardless of who makes the expenditure—such as employer-paid medical services. The CPI is used to index government benefits and many private sector wage contracts. The PCE-deflator is used by the Federal Reserve to understand inflation trends.

In any event, the PCE-deflator was up 2.7% in April versus a year earlier, the same as in March. The index was up 0.3% from the previous month, the same as in February and March. When volatile food and energy prices are excluded, the core PCE-deflator was up 2.8% in April versus a year earlier, the same as in February and March. The core index was up 0.2% from the previous month, the smallest increase since December. 

Not surprisingly, the remaining inflation largely involves rising service prices. The government reported that prices of durable goods were down 2.2% in April from a year earlier, while prices of non-durable goods were up 1.4%, the biggest gain since December. The latter was likely due to an acceleration in energy prices. Prices of services, however, were up 3.9%, roughly in line with the pattern of the last several months. Naturally, the service number is of most concern to Fed policymakers. After all, services are labor-intensive, the labor market is tight, and wages are rising too fast for comfort.

On the other hand, the Fed has long said that the 2% inflation target is not meant to be a ceiling but rather an average. Thus, if underlying inflation stays below 3%, the Fed will likely be comfortable. Thus, with consumer demand weakening and core inflation staying below 3%, an initial rate cut in September seems reasonable to expect. US bond yields, meanwhile, fell slightly.  

US home prices accelerate

  • US home prices accelerated in March, with prices rising from a year earlier for the ninth consecutive month. The well-known S&P Case Shiller index of home prices in 20 major US cities was up 7.4% in March from a year earlier, the biggest increase since October 2022. Prices were up 1.6% from the previous month, the biggest increase since April 2023. The index is now at an all-time high, 57.4% above the cyclical peak reached in 2006 and 142.5% above the cyclical trough reached in 2012. 

Housing is a collection of local markets, and local market conditions vary. The biggest annual price increases took place in San Diego, New York, Los Angeles, and Cleveland. The smallest increases took place in Denver, Portland, Dallas, and Tampa. 

Home prices are now rising considerably faster than consumer prices. Thus, homeowners are seeing a real (inflation-adjusted) increase in their housing wealth. Yet many remain reluctant to sell given that many currently pay very low–interest rates on their mortgages. Meanwhile, mortgage rates remain very high. This has created a paucity of supply, contributing to a rise in prices. On the other hand, rising prices will likely stimulate more construction of new homes.  

Eurozone inflation accelerates while the ECB considers its next move

  • In the Eurozone, inflation accelerated slightly in May. The consumer price index rose 2.6% in May versus a year earlier, higher than the 2.4% increase in both February and March. Energy prices rebounded slightly in May after having fallen in the previous month. Food price inflation fell slightly in May. When volatile food and energy prices are excluded, core prices were up 2.9% in May versus a year earlier, higher than the 2.7% in April but the same as in March. 

As previously in the Eurozone and as is true in other Western countries, inflation is highest for services. Prices of services were up 4.1% from a year earlier, up from 3.7% in the previous month and the highest rate of services inflation since October. In part, this acceleration reflected the rebound in energy prices. Meanwhile, non-energy goods prices were up 0.8% in May versus a year earlier, a very low number compared to recent months. The latest data suggests that the deceleration of inflation in the Eurozone has stalled. Still, the numbers are low, below 3%, and the economy remains weak.  

By country, here are the annual inflation rates for May: Prices were up 2.8% in Germany, up 2.7% in France, up 0.8% in Italy, up 3.8% in Spain, up 2.7% in the Netherlands, up 4.9% in Belgium, up 2.3% in Greece, up 3.9% in Portugal, and up 0.5% in Finland. The wide disparity is a challenge for the European Central Bank (ECB). 

  • It appears increasingly likely that the ECB will cut interest rates very soon, becoming the first of the three major Western central banks (the United States, the United Kingdom, Eurozone) to do so. However, several smaller central banks (Switzerland, Sweden, Czechia, and Hungary) have already cut rates this year. The chief economist of the ECB, Philip Lane, said that “barring major surprises, at this point in time there is enough in what we see to remove the top level of restriction.”

Currently, the benchmark interest rate of the ECB is 4%, much higher than the 5.25%–5.5% range for the Federal Reserve’s benchmark rate. Yet in the Eurozone, inflation has fallen faster than in the United States. Moreover, while US economic growth has been strong, growth in the Eurozone has been slow. Thus, it is no surprise that investors are now pricing in a high probability of a rate cut at the next policy committee meeting. 

Meanwhile, although inflation has receded, inflation for services remains too high. Moreover, services tend to be labor-intensive and labor markets in many Eurozone economies are tight. Thus, the ECB is likely concerned about this. Consequently, even if it cuts rates, it might choose to cut them very gradually in the coming months–at least until it is confident that underlying inflation is falling. 

Although the ECB has a single mandate to minimize inflation, it is likely that the committee members have an eye on the health of the overall economy. The fact that the Eurozone just barely avoided recession in 2023 probably contributes to the committee’s calculus. 

Finally, if the ECB cuts rates soon, it will reinforce the weakness of the euro against the US dollar. Still, investors expect a rate cut, and so this is likely already incorporated into currency markets. Only if the ECB cuts rates more quickly than anticipated will it lead to a further decline in the value of the euro. The problem with a weak currency is that it boosts the cost of imported commodities and can feed inflation. On the other hand, a weak currency can boost export competitiveness. 

China’s currency has not yet internationalized

  • China’s government wants China’s currency, the renminbi, to become an important global currency. It wants a large share of global trade to take place in the renminbi and it wants businesses and central banks to hold a large amount of renminbi-denominated assets. Most importantly, it wants these things to reduce its vulnerability to the United States. Because the US dollar is dominant in the world, the United States can utilize the dollar, and levy sanctions on governments that are not aligned to US goals. The sanctions imposed on Russia are an example. In addition, the United States has what has been called an “exorbitant privilege” to borrow money in its own currency, thereby eliminating exchange risk. Moreover, the deep and liquid market for dollar-denominated assets ensures that US borrowing costs are lower than otherwise. China wants to enjoy these benefits given that it is now the second largest economy in the world. 

To this end China has developed currency-swap arrangements with many countries while it has encouraged Chinese companies to transact internationally in renminbi. Yet despite this goal, progress has been slow. Although the share of global trade taking place in renminbi has increased considerably, it remains very low. 

A new survey of companies offers insights into why the renminbi is not more widely used. The Cross-Border Yuan Insight report, produced by China’s Bank of Communications and Renmin University, involved a survey of 1,657 companies of which 71% are private sector Chinese companies, 13% are state-owned enterprises, and 15% are foreign-funded enterprises.  

The survey found that 47.7% of respondents said that a lack of interest in the renminbi on the part of trading partners is the principal reason for the paucity of transactions in renminbi. In addition, 63.8% of respondents noted the “complexity of policies” as a deterrent to transacting in renminbi. Also, 40% cited “compatibility of laws and regulations” and “capital-flow barriers.” Finally, 30% cited “limited investment scope” while 20% cited a lack of hedging tools. 

These numbers confirm what many observers already know, which is that capital controls hamper the ability of China to internationalize its currency. Moreover, capital controls limit the ability of global investors to invest in renminbi. Consider an example: Imagine a farmer in Argentina who exports wheat. If the farmer is asked how he/she wants to be paid for the wheat and is given the choice of US dollars or Chinese renminbi, the answer will most likely be dollars. Why? The answer is that capital controls preclude flexibility. That is, if the farmer takes renminbi and invests in Chinese assets in China, there will be a question as to the ability to liquidate the assets. Plus, it would be difficult to invest renminbi outside of China. None of this would be as true of dollar-denominated assets. 

Thus, the best way for China to internationalize its currency would be to eliminate capital controls. Yet in so doing, it would make the currency vulnerable to considerable volatility. Absent capital controls, China’s central bank would not be able to simultaneously target the value of the currency while maintaining an independent monetary policy. It would have to give up one or the other tool. That is, it could maintain control of monetary policy but might have to contend with sharp currency depreciation. On the other hand, by eliminating capital controls China would likely see a significant rise in renminbi-based transactions.  

Chinese consumers remain cautious

  • One of the reasons for China’s relatively slow economic growth is that household spending is growing slowly. One explanation is that the loss of wealth from declining home prices is likely discouraging people from spending and encouraging them to rebuild their wealth by saving. Another explanation is that people are uncertain about their financial security given problems in the property market and given relatively slow economic growth.

Whatever the reason, a recent survey suggests that consumers remain cautious in their spending plans. A survey conducted by Southwestern University of Finance and Economics in Chengdu, Sichuan province, found that an index of family future spending expectations is now lower than during the early days of the pandemic. Moreover, the index fell from the fourth quarter of 2023 to the first quarter of 2024. The first quarter reading is lower than in the second quarter of 2020, at the height of the pandemic.

The index is a diffusion index in which readings above 100 indicate more people intend to spend more than intend to spend less—and vice versa. The reading in the first quarter of 2024 was 101.9. The survey is based on answers obtained from middle-income households. The survey found that households were especially cautious about purchasing property—not surprising given the state of the Chinese residential property market.


Ira Kalish

United States


Cover image by: Sofia Sergi