Limited functionality available
What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
The latest economic data from China offer a mixed, but mostly negative, picture of China’s economic fortunes. Retail sales and industrial production are decelerating, with retail sales falling at the fastest pace in 15 years; fixed asset investment has started to rebound modestly after a period of considerable weakness; and trade is decelerating as the trade wars intensify.1 The weak Chinese data, combined with declining purchasing managers’ indices (PMIs)2 for both Europe and the United States, shook global investors, leading to sharp declines in equity and commodity prices. However, US President Trump welcomed the Chinese weakness, suggesting it bodes well for obtaining a trade deal. He tweeted that “China just announced that their economy is growing much slower than anticipated because of our Trade War with them. [The United States] is doing very well. China wants to make a big and very comprehensive deal. It could happen, and rather soon!”3
Here are the details regarding the Chinese economic data.
Retail sales decelerated in November. Sales were up 8.1 percent in November versus a year earlier, down from 8.6 percent in the previous month.4 This was the slowest growth in retail sales since May 2003. The weakness was partly due to a 10.0 percent drop in automotive sales as well as a 5.9 percent decline in sales of telecoms equipment. At the same time, sales were relatively strong for apparel, cosmetics, personal care products, home appliances, and building equipment. The overall weakness of retail spending was a disappointment for the government, which had hoped that a tax cut implemented in October would boost consumer spending.5 The government wants domestic demand to offset any weakness in exports that comes from the current trade war. However, the tax cut was likely offset by the expiration of tax rebates for smaller vehicles.6 In addition, the government has cracked down on peer-to-peer lending sites, thus effectively reducing the availability of credit. Moreover, consumer debt in China has already risen to an unusually high level, which might mitigate against more consumer borrowing. Finally, in the coming year, the government will implement new tax measures that will allow consumers to deduct certain expenses,7 thereby effectively increasing their after-tax income.
Automotive sales fell in November for the sixth consecutive month. Sales of automobiles were down 14 percent in November versus a year earlier.8 Thus the stage is set for 2018 sales to be lower than in the previous year, the first annual decline since the 1990s. There are a number of possible explanations. Asset prices have performed poorly in China, hurting the wealth of consumers, which is critical for car buyers. In July, China imposed a 40.0 percent tariff on cars imported from the United States, although it recently announced plans to temporarily drop the tariff to 15 percent. Moreover, the psychological effect of the trade war is said to have dampened consumer sentiment. Also, a tax rebate that had been implemented to stimulate car sales has expired. Finally, there has been a rapid increase in the use of ridesharing services in China’s major cities, reducing the need to own vehicles. Currently, cars used for ridesharing services account for 13.0 percent of vehicles on the road, a figure that is expected to increase sharply in the next few years. The weakening of automotive sales in China will likely have broad implications. Imported and foreign brand cars account for 62.0 percent of sales in China. As the world’s largest automotive market declines, global automotive companies will feel the impact.9
The government reports that both exports and imports decelerated considerably in November. Specifically, exports (evaluated in US dollars) were up only 5.4 percent in November versus a year earlier. This was way down from growth of 15.6 percent in October. Imports were up only 3.0 percent in November versus a year earlier, compared to growth of 21.4 percent in October.10 The weakness in exports was likely related to the trade war, with the United States having already imposed significant tariffs and threatening to impose more. Indeed, exports to the United States decelerated. At the same time, the weakening of the renminbi in the past year probably helped to offset some of the damage. The weakness of imports is an indication of weakening domestic demand.
Industrial production grew 5.4 percent in November versus a year earlier, slower than the 5.9 percent growth11 in October and the slowest growth since early 2016. Manufacturing output was up 5.6 percent, a slowdown from the previous month. The weakness was likely due, in part, to slower orders for exports, the result of trade tensions and tariffs.
Fixed asset investment has begun to rebound after historically slow growth. In August, investment for the first eight months of the year was up 5.3 percent from a year earlier, the slowest rate of growth on record. Since then, there has been a gradual recovery. In November, investment in the first 11 months of the year was up 5.9 percent, an improvement from the 5.7 percent growth of the previous month.12 The acceleration was entirely due to public sector investment, which accelerated from 1.8 percent growth in October to 2.3 percent growth in November. Private sector investment, while faster, decelerated from 8.8 percent growth in October to 8.7 percent in November.
China’s economic slowdown is also evident in a decline in imports of key commodities. It is reported that Chinese imports of copper fell 3.0 percent in November from a year earlier. This reflects a weakening of such sectors as housing, automobiles, and telecoms. The price of copper is down about 15.0 percent from a year earlier. In addition, imports of iron ore, the key component in the production of steel, fell 8.8 percent in November from a year earlier. This reflects weakness in construction.13 Chinese steel prices have fallen 12.0 percent14 in the past year as domestic production surged while demand lagged. In the coming year, the government is expected to boost investment in infrastructure in order to stabilize the decelerating economy. If successful, this could lead to an increase in imports of copper and iron ore, and an increase in the prices of these commodities.
Last week was unusually eventful for the British government and Parliament, the result of which is continued uncertainty. It all began when the Parliament was set to vote on the Brexit deal that Prime Minister May reached with the European Union (EU). Yet, before a vote could take place, Theresa May announced that the vote would be delayed because it “would be rejected by a significant margin.”15 The leadership of the main opposition party, the Labour Party, as well as other smaller and regional parties, such as the Scottish National Party and the Liberal Democrats, had all said they would vote against the deal negotiated by the government. Indeed, a number of the government’s own members of Parliament (MPs) had come out publicly to say that they would vote against the deal as well. It would have been a major defeat. In announcing the withdrawal, May said, “It is clear that while there is broad support for many of the key aspects of the deal, on one issue, the Northern Ireland backstop, there remains widespread and deep concern.” In response to the announcement, the pound fell against the dollar and euro, and British government bond yields fell as well, indicating the continued uncertainty with regard to the future economic prospects for the UK economy and the impact of Brexit.
Prior to the meaningful vote being delayed, the European Court of Justice ruled that Britain is free to revoke its activation of Article 50 (exiting the EU) unilaterally and without the consent of other members of the EU.16 The ruling handed down by the court said that “a member state cannot be forced to leave the [EU] against its will.” With THE MEANINGFUL VOTE on the Withdrawal Agreement facing an uphill challenge in being passed in the UK House of Commons due to the number of MPs who oppose the deal, the risk of a no-deal Brexit is rising. Also rising is discussion among some MPs over the possibility of holding a second referendum, although questions remain as to what the wording of such a referendum would be and its timing (in that it would require an extension to the Article 50 period to hold the referendum).
In any event, the current government opposes the holding of a second referendum, or revoking or extending Article 50. In a statement, a government spokesman said that the court’s decision “does nothing, in any event, to change the clear position of the government that Article 50 is not going to be revoked.”
Meanwhile, the prime minister survived a vote of confidence from her own Tory colleagues in the “1922 Committee,” which is the parliamentary group of the Conservative Party in the House of Commons. The vote was 200 in favor of May and 117 against. That was closer than many observers had expected, and it indicated a deep divide within the party. Under the rules of the 1922 Committee, May is now safe for 12 months from another leadership challenge, although it would not prevent her from resigning, nor stop a motion of no confidence in the full House of Commons that would be a first step towards the triggering of a general election.17
As for the deal with the EU, the prime minister has said that she would continue to negotiate with the EU to gain certainty that the backstop (meant to prevent the return of a hard border between the Republic of Ireland and Northern Ireland) contained in the Withdrawal Agreement could not be an indefinite fallback, in order to gain support in the UK Parliament. Yet European Commission President Jean Claude Juncker said that there is “no room whatsoever” for any changes to the 585-page treaty.18 The leaders of Germany and France expressed a similar sentiment. However, Juncker said that he is amenable to clarification of the backstop. Many members of May’s Conservative Party in Parliament have said that they want a legally-binding renegotiation of the Withdrawal Agreement. Thus, it is not clear if a mere “clarification” will suffice to gain their support. Meanwhile, the government says that it will reschedule the vote to take place during the week commencing 14 January. May said that Britain faces a choice between the deal and no deal under her government. If the Parliament ultimately votes against May’s deal, other possibilities include a change in leadership of the Conservative Party or a general election.
In the first sign that trade tensions between the United States and China might be abating, the Chinese government announced that it will lower tariffs on automobiles imported from the United States. Recall that, last July, China cut the tariff on imported automobiles from 25.0 percent to 15.0 percent as a concession to the United States, which was threatening increased tariffs. Then, days later, when the United States announced new tariffs, China retaliated by boosting the tariff from 15.0 percent to 40.0 percent. Now, as a gesture aimed at easing the tension, China says that it will cut the tariff again from 40.0 percent to 15.0 percent.19 Meanwhile, at the G20 summit recently, the United States and China agreed to a 90-day truce, during which time negotiations will take place and no new tariffs will be implemented. At the end of that 90-day period, the United States says that it will boost tariffs if no new trade deal is reached. In that case, it would be likely that China would revert to higher tariffs as well as retaliatory non-tariff barriers.
Negotiations between the United States and China will not actually commence until January, leaving very little time to reach a deal on highly complex issues. Still, despite the formidable obstacles to reaching a trade deal, many investors were evidently pleased by China’s announcement on automotive tariffs. Global equity prices increased sharply following the announcement about automotive tariffs, with especially large increases in the share prices of US companies with substantial exposure to China.20
For his part, President Trump has lately offered more conciliatory remarks about China than his hardline trade advisors. However, in the past, he has generally sided with the hardliners rather than with the trade moderates. Still, it is reported that he is concerned about two issues. First, the beating that equity prices have taken as a result of trade uncertainty concerns him. In the past, he has pointed to rising equity prices as an indication of the success of his policies. Second, an important constituency for him is the agricultural industry, which has been hammered due to retaliatory tariffs imposed by China on US farm exports. Plus, US tariffs on steel imports have boosted the cost US farmers face in storing excess output.21 Indeed, the stock of soybean inventory in the United States has jumped dramatically in recent months as farmers struggle to sell their product. Trump might decide to accept a modest deal with China in order to avert equity-market trouble and in order to avoid political troubles with the farm community. Such a deal would likely involve China removing obstacles to US farm exports. When China imposed steep import tariffs on US-produced soybeans, US exports of soybeans to China halted as Chinese importers largely switched to Brazilian suppliers. However, last week a large volume of US-produced soybeans was sold to China.22 This suggests that China’s government might be moving to seek a resolution of the trade dispute with the United States.
The Chinese government is clearly worried about the potential impact of trade wars. It has indicated that it will focus on building a strong domestic market in order to offset external headwinds. Meanwhile, it reports that inbound foreign direct investment (FDI) was down 27.6 percent in November versus a year earlier.23 That was prior to the ceasefire agreed upon between the United States and China. It is likely that the decline in FDI was related to investor concerns about the trade dispute.
Four years ago, the European Central Bank (ECB), following the lead of the US Federal Reserve and the Bank of England, began a program of asset purchases, known as quantitative easing. The idea was to circumvent the troubled banking system in order to inject liquidity into the economy. The program has been a success in that it led to moderate growth of the money supply at a time when the money supply might otherwise have shrunk. The result of this was downward pressure on the euro, inflation rather than deflation, low borrowing costs, and improved credit market performance. At the same time, the program did not lead to ruinously high inflation as many critics had anticipated.
Still, it was never meant to last forever and, as expected, the ECB has announced the formal end of its quantitative easing program. Starting in 2019, the ECB will no longer engage in asset purchases, despite the fact that the Eurozone economy appears to be decelerating.24 Mario Draghi, President of the ECB, noted that, when quantitative easing began, the ECB was “the only driver of this recovery.” Yet, since then, the economy has recovered sufficiently that the ECB is no longer needed to assure credit market activity. Still, given high unemployment and low inflation, the ECB expects to maintain historically low interest rates for some time to come. It has already lowered its growth forecast for 2019. However, without ECB participation in government bond markets, it is possible that bond yields will likely rise further, depending on the strength of the economy and the degree of government borrowing. The absence of the ECB in the market could act as a constraint on government fiscal largesse.
The yield on US Treasury bonds has fallen significantly in recent weeks, with the yield on the 10-year bond falling below 3.0 percent25 for the first time in more than two months. Why? To understand this, it is helpful to deconstruct the yield. There are two components to the yield: an expectation of inflation and the real (inflation-adjusted) yield, which reflects supply and demand conditions in the bond market. Amazingly, these two components can be precisely quantified. That is because the US Treasury issues a bond whose principal moves in line with inflation. That bond, known as the Treasury Inflation Protected Security (TIPS), has a yield that is actually the real (inflation-adjusted) return. Thus, if the yield on TIPS is subtracted from the yield on the 10-year bond, the result is the 10-year expected rate of inflation, which is known as the breakeven rate. Let’s consider both components.
A fall in overall bond yields could help to lessen the burden on businesses, many of which are laden with debt. Moreover, it could help to reduce mortgage interest rates that, having risen in the past year, have had a negative impact on housing market activity. The future direction of bond yields will depend on Fed policy, trade policy, energy prices, and overall conditions in the economy. As for the Fed, its policy could be influenced by expectations of inflation. After all, its job, in part, is to anchor expectations of inflation. The drop in expected inflation could lead the Fed to slow the pace of interest rate increases. On the other hand, the rise in the dollar and the fall in oil prices could be seen as only temporary influences on inflation expectations. If so, the Fed might not necessarily adjust policy in response to the drop in expectations of inflation.
Meanwhile, if the Federal Reserve, by raising short-term rates, is successful in suppressing inflation expectations (and thereby reducing bond yields), the result could be an inversion of the yield curve in which case short-term rates exceed long-term rates. We are close to that point. In the post-war era, all recessions were preceded by an inversion of the yield curve, and almost all inversions were soon followed by a recession.
In the past week, global equity prices plummeted amidst confusion about the trading relationship between the United States and China, and amidst worries about the outlook for the US economy. US equity prices are now roughly where they were a year ago, with all of the past year’s gains having been wiped out. Likewise, European and Asian shares have fallen sharply as well.
First, investors like certainty regarding trade, and there is not much of that. Moreover, communication by the US administration about the US relationship with China has been inconsistent, providing investors with concern about what is actually happening. It began when the US administration announced that a major agreement had been reached with China, which President Trump described as “an incredible deal.” Yet there was no communique; there was also no acknowledgement from the Chinese of any such agreement until several days after the US announcement. However, the US side appeared to undermine earlier statements, with the US president saying, “President Xi and I want this deal to happen, and it probably will. But, if not, remember, I am a tariff man. When people or countries come in to raid the great wealth of our nation, I want them to pay for the privilege of doing so.”28 Not only did this statement suggest that a deal was not necessarily imminent. It also suggested that the president sees the tariffs as beneficial and as being paid by the Chinese. It reflected a view that foreign governments must pay for the privilege of selling goods into the United States. However, tariffs are actually paid by the consumers and businesses of the country that imposes them and, by raising prices, can have significant negative effects. Even proponents of tariffs generally believe that the negative cost of a tariff is acceptable if it leads foreign countries to change their behavior and open their markets. In any event, it appears that investors were spooked by these various remarks, especially the accolades about tariffs. After a degree of euphoria following the initial announcement of a deal, investors were no longer certain about the nature of the deal. Although the Chinese government ultimately acknowledged that a deal did in fact exist, and that it will implement the terms, it did not offer any information about the details of the deal. Meanwhile, investors are now fearful that the tariffs previously anticipated could once again be imminent.
Second, the sharp drop in US bond yields,29 along with the fact that the yield curve appears to be on the verge of inverting, suggests investor pessimism about the outlook for the US economy. A panoply of factors is causing a reassessment of growth prospects. These include the tightening of US monetary policy, evidence of trouble in some sectors of the US economy (such as housing, business investment, and exports), evidence of a slowing global economy (especially in Europe and China), and fears about the potential impact of trade wars. If there is a general global slowdown, it would have a negative impact on corporate profitability. Finally, the rise in short-term interest rates in the United States could be a factor in bursting asset-price bubbles. Hence, the drop in equity prices.
At the recent G20 summit in Buenos Aires, the leaders of the United States, Mexico, and Canada signed the new trade deal that is intended to replace North American Free Trade Agreement (NAFTA), known as the US-Mexico-Canada Agreement (USMCA). However, the new deal will not take effect until approved by the legislative bodies of all three countries. The only one in doubt is the US Congress, where President Trump faces potential hurdles in lining up support in the soon-to-be Democratic controlled House of Representatives. To assure support, Trump is now saying that the Congress will have a choice between the new agreement and a reversion to pre-NAFTA trading relations.33 This is meant to scare members into supporting the new deal. Specifically, Trump said he will soon inform Mexico and Canada of the US intention to withdraw from NAFTA within six months. He said, “I'll be terminating it within a relatively short period of time. And so Congress will have a choice of the USMCA or pre-NAFTA.” Meanwhile, there remains concern34 about the new USMCA on the part of both Democrats and Republicans. Some Democrats believe that the provisions on enforcement of labor standards are not sufficiently strong, and some Republicans object to the provision that bars discrimination on the basis of sexual orientation. Also, some members of Congress suggest that passage of the USMCA would be more likely if the United States relieves Mexico and Canada of tariffs on steel and aluminum imports. Meanwhile, incoming House Speaker Nancy Pelosi said that “while there are positive things in this proposed trade agreement, it is just a list without real enforcement of the labor and environmental protections.” She recently met with US trade negotiator Robert Lighthizer to discuss her concerns. She said that she is waiting for Mexico to “pass its promised law on the wages and working conditions of Mexican workers competing with American workers.” There is a strong chance that the House will seek to make changes to the agreement before giving its approval. For his part, Lighthizer said, “I’ve been in discussions with a variety of Democratic leaders on those points and they’ll be very much involved in the process moving forward and will have an influence, a strong influence. I want them not only to vote for it, I want them to be happy with the agreement.” The uncertainty surrounding the outcome of this debate means that companies with operations in North America cannot yet make firm plans.
There seems to be uncertainty at the moment about the future direction of monetary policy in the United States. That uncertainty stems, in part, from seemingly conflicting comments by Federal Reserve officials last week. It all began when, in a speech, Federal Reserve Chairman Jay Powell appeared to hint that interest rate increases are almost over. In response, financial markets were euphoric, with US equity prices rising sharply and bond yields falling.35 What Powell actually said is, “Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy that is, neither speeding up nor slowing down growth.”36 This is the sentence that attracted the financial world’s attention. Why? The answer is that many investors believe that, once interest rates are at the neutral level, the Fed will likely stop raising rates. Yet it is not clear that this is true. Indeed, Powell went on to say, “Our gradual pace of raising interest rates has been an exercise in balancing risks. We know that moving too fast would risk shortening the expansion. We also know that moving too slowly—keeping interest rates too low for too long—could risk other distortions in the form of higher inflation or destabilizing financial imbalances. Our path of gradual increases has been designed to balance these two risks, both of which we must take seriously.” In other words, and in the parlance of poker, he did not really reveal his hand. Indeed, he said that “there is no pre-set policy.” Still, investors were spooked in October when Powell said that rates were far below the neutral level.37 That statement led to a nosedive in equity prices.38 The latest statement, therefore, had the opposite effect. Powell’s speech did not actually offer significantly new information, but investors were evidently eager for good news after equity prices had fallen sharply in recent weeks. Meanwhile, Powell’s remarks come at a time when he is under unusual pressure from the president. Trump said this week, “So far, I am not even a little bit happy with my selection of Jay.”39 Still, it is not likely that Powell will do anything in response to these comments. The Fed is institutionally independent, and the Fed Chairman cannot be fired. Finally, Powell’s speech was mostly about financial stability. He said, “Over the past year, firms with high leverage and interest burdens have been increasing their debt loads the most. In addition, other measures of underwriting quality have deteriorated, and leverage multiples have moved up.” This comment can be taken in two different ways. On the one hand, he appears to be concerned about a rise in debt, and an increase in interest rates would be helpful in stemming this increase. On the other hand, rising interest rates will increase the difficulty faced in servicing excessive debt, and could precipitate a crisis.
Meanwhile, the day after Powell’s speech, the Fed released the minutes from its last meeting, which indicate that it still expects to keep raising rates40 and that it believes the economy is growing faster than it can without fueling higher inflation. Moreover, the policy committee members were nearly unanimous in their view that further rate increases in 2019 are warranted. In addition, the committee agreed that it should soon raise its target range for interest rates. However, the committee members acknowledged some factors could cause the economy to decelerate in the next two years, thereby potentially suppressing inflationary pressures. These include the current stance of fiscal policy, which will entail a drop in spending by 2020; the future lagged effect of the current increases in interest rates; the potential impact of the trade disputes between the United States and its trading partners; and the potential impact of excessive debt in the private sector. The members noted that, already, there is a weakening in the critical housing sector. Equity prices fell modestly in response to this news. Thus, to summarize, investors were offered a wide range of evidence by the Federal Reserve about its future intentions, but they were left without certainty about where the Fed is going. Nevertheless, it is likely to keep a close eye on measures of inflation, expectations of inflation, tightness in the job market, and other factors that might influence the direction of the economy.
Finally, the Federal Reserve’s favorite measure of inflation indicates that inflation remains tame. The personal consumption expenditure deflator (PCE-deflator) was up 0.2 percent from September to October and up 2.0 percent from a year earlier.41 The latter number is a deceleration from the 2.3 percent inflation clocked in May, June, and July. When volatile food and energy prices are excluded, core prices were up 0.1 percent for the month and up 1.8 percent from a year earlier. The latter figure is also a deceleration from the 2.0 percent clocked in May, June, and July. The fact that inflation appears to be easing, rather than accelerating, will surely be important information for the Federal Reserve as it deliberates. Why is inflation waning? One possible reason is the sharp drop in energy prices, which indirectly feeds into other prices as well. Another reason could be the sharp rise in the value of the US dollar in the past year, which has had a negative impact on import prices. Yet these two factors are likely seen as ephemeral by the Fed. Consequently, the Fed might actually be more likely to continue down the path of monetary tightening if it believes that the weakening of inflation is temporary.
At the G20 summit in Buenos Aires, the presidents of the United States and China had a much-anticipated dinner meant to resolve a trade dispute that was threatening to worsen. The US side had said that, absent an agreement in Buenos Aires, it would boost tariffs on US$200 billion of imports from 10 percent to 25 percent, and that it might impose new tariffs on all remaining imports from China. In the end, the two sides agreed to put tariffs aside for 90 days while negotiations take place with the intention of resolving a number of issues raised by the United States,42 including complaints about China’s failure to protect intellectual property, Chinese restrictions on foreign investment, and China’s large trade surplus with the United States. China agreed to boost imports of some products from the United States, but the amounts were not specified. The United States hailed the dinner agreement,43 but the reality is that it is likely a temporary ceasefire. During the next 90 days, businesses will continue to face an uncertain trading environment, which has probably had a chilling effect on business investment and on new export orders. Thus, the agreement does not resolve the uncertainty that has already had a negative impact on economic activity.44 Still, many business groups in the United States praised the agreement for putting tariffs aside—at least temporarily.
What are the chances of reaching an agreement in 90 days? It depends on how the US side defines success. A vague deal in which China commits to making changes, even if cosmetic, might be sufficient from the US perspective. After all, it is reported that the White House fears that the lack of a deal would lead to a further sharp drop in equity prices and damage the economy.45 On the other hand, it is also reported that the White House is reluctant to make the kind of vague deal for which it has criticized former administrations. It worries that its core supporters will see the administration as having caved in the face of adversity. Moreover, if the US side defines success as a firm commitment to specific targets for the trade balance between the two sides, then an agreement is unlikely. That is because trade balances are not determined by trading rules. Rather, trade balances reflect differences between what a country saves and what it invests. In the case of China, its overall trade surplus has actually been declining as investment has decelerated. Yet the US trade deficit has been rising, likely reflecting the impact of strong demand and a rising budget deficit. Reducing the US trade deficit, therefore, will not require action by China. Rather, it will require a change in US fiscal policy. Finally, it is reported that, within the administration, Treasury Secretary Steve Mnuchin and economic advisor Larry Kudlow are amenable to a modest deal, while trade negotiator Robert Lighthizer, trade advisor Peter Navarro, and national security advisor John Bolton take a more hardline position. In the past, this situation has usually resulted in the president siding with the hardliners.46
If no agreement between the United States and China is reached after 90 days, and if the United States then imposes all of the tariffs that it has proposed, the economic consequences could be significant. The default position of many investors has been that the United States and China will, at the least, agree to a permanent ceasefire, and that new tariffs will not be implemented.47 Thus, eventually, if there are new tariffs, investors will have to reevaluate the situation, likely leading to further downward pressure on the Chinese renminbi, and downward pressure on US and Chinese equities. Downward pressure on the renminbi could lead the Chinese authorities to either sell reserves in order to stabilize the currency, or choose to allow the currency to fall in order to offset the impact of tariffs. A sharp drop in the renminbi could lead to downward pressure on other Asian currencies as well.48 That, in turn, could create turmoil in Asian financial markets and could lead other Asian countries to tighten monetary policy. The tariffs would likely cause a boost in prices paid by US consumers, leading to slower growth of spending. Tariffs would cause increased costs for companies that import components, leading either to higher prices and/or lower profit margins. The tariffs would likely inhibit new investments, and might lead companies to shift supply chain investments to other countries. Moreover, if the United States does impose further tariffs, it is likely that China would seek to retaliate, not with tariffs but with nontariff barriers. This could include restrictions, both form and informal, on the ability of US companies to operate in China.
European Central Bank (ECB) President Mario Draghi says that the ECB intends to end quantitative easing (asset purchases) by the end of the year,49 despite evidence of a slowdown in economic growth in Europe. He said that, despite the slowdown, he expects inflation to “gradually rise” further, thereby justifying a shift in monetary policy. Draghi argues that the strong economic growth seen in 2017 was an aberration, and that the deceleration currently under way represents a return to a more normal rate of growth. In addition, Draghi noted that unemployment in the Eurozone is at its lowest level since 2008. He said, “Wages are rising as labor markets continue to improve and labor supply shortages become increasingly binding in some countries.” In other words, even with slower economic growth, the state of the labor market is such that inflationary pressures could increase. Moreover, he noted that, although the ECB will soon end asset purchases, it intends to keep interest rates historically low. Thus, monetary policy is hardly being tightened.
Meanwhile, the European Union released the latest data on inflation in the Eurozone.50 Inflation remains tame and has even decelerated. Specifically, consumer prices were up 2.0 percent in November versus a year earlier, down from 2.2 percent inflation in the previous month and the lowest headline rate since August. More importantly, when volatile food and energy prices are excluded, core prices were up 1.0 percent in November versus a year earlier, well below the ECB’s target of 2.0 percent inflation. Core inflation has remained in the range of 0.9–1.1 percent for most of the past year. As such, it appears that underlying inflation is without direction. The low level of inflation in Europe likely reflects the fact that unemployment remains high in three of the four largest economies in the Eurozone (Italy, Spain, and France). Indeed, only one country in the Eurozone—Greece—had a higher unemployment rate than these three in November. Moreover, the unemployment rate in the Eurozone remained at 8.1 percent in November for the fourth consecutive month.51 This slack in the labor market, combined with the fact that economic growth is decelerating in the Eurozone, mitigates sizable wage increases. In addition, the current decline in energy prices is likely to have a dampening effect on headline inflation in the months ahead. Thus, it makes sense to expect that monetary policy will remain easy.