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Using trade policy for strategic ends will be harder than Macron thinks



Aux armes, citoyens. Two years ago, the EU — under the guidance of Ursula von der Leyen’s self-labelled “geopolitical Commission” — adopted the ambitious but vague goal of developing European “strategic autonomy” on a global level.

Although invoked almost daily in Brussels, the concept has remained aspirational, even abstract. Meanwhile, the EU faces real and specific menaces, with China blocking Lithuania’s exports and Russia threatening to invade Ukraine. This would be a good time to turn the EU’s undoubted clout in trade policy to strategic ends to resist pressure from hostile governments.

Enter, to the sound of bugles and the thundering of horses’ hooves, a cavalry charge led by Emmanuel Macron. The French president is leading the council of EU member states for the next six months — assuming he is re-elected in April — and will aim to overcome EU disunity and France’s own vulnerabilities to build European geopolitical power.

In theory, it’s just what the EU needs — leadership from a big member state with its own renowned military, intelligence and diplomatic capability. For the council presidency, Macron has adopted a rallying cry — “relance, puissance, appartenance” (“recovery, power, belonging”) — with more than a whiff of revolutionary zeal. He also has a personal motive to build European strategic power independent of its traditional allies, following last September’s humiliation of being ambushed by the Australia-UK-US (Aukus) security pact and its deal on nuclear submarines.

With excellent timing, the EU is creating a new trade weapon, a legal “anti-coercion” instrument, which France wants to fast-track. The tool will allow rapid retaliation with trade, investment and financial measures against illegitimate pressure from foreign governments. In the future, it will hopefully deter the likes of China from bullying EU states such as Lithuania.

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But multiple vulnerabilities hamper France’s ability to lead the repurposing of EU trade policy for strategic ends.

The first is foreign policy disunity within the EU towards China, Russia and the US. Macron is frequently at odds with some member states in the eastern half of Europe, in particular over his previous emollience towards President Vladimir Putin. Given Russia’s belligerence over Ukraine, and the Russia-linked mercenaries sent despite French objections to Mali, where France is winding down a peacekeeping force, that looks to have been a bad bet.

Similarly, despite being critical of Chinese trade policy, Macron in 2020 unwisely succumbed to German persuasion to support the EU’s bilateral investment agreement with China. The deal, now mercifully suspended, caused dismay across the EU and within Joe Biden’s incoming administration in the US for making Europe look weak.

Indeed, Macron’s sceptical attitude to the US suggests he is overly animated by French interests, particularly the Aukus episode. Given Biden’s foreign policy vacillations and the possibility of another Donald Trump presidency, he is right about the risks from reflexive Atlanticism. But other European countries such as the Baltic states are not confident the EU, with its limited trade and financial sanctions instruments, can take over. The US is Russia’s main interlocutor in this week’s talks in Geneva on European security: the EU institutions are not invited. Support from other member states for France’s fury over the Aukus deal was slow and muted.

Second, France is often too politically vulnerable domestically to wield trade as an effective strategic weapon. A slightly childish but symbolically unequivocal way to punish Australia over Aukus would have been to complete the EU’s nearly finished bilateral trade deal with New Zealand, a country that bans nuclear submarines from its ports, while blocking a parallel Australian agreement. But both countries are beef exporters, France’s presidential election is coming up and the country’s cattle farmers are notoriously noisy. Paris has elected to delay both deals until it’s someone else’s problem.

Notably, the “strategic autonomy” slogan started life as “open strategic autonomy”, but France last year argued vehemently for dropping even an abstract reference to free trade. There is concern among other member states that the anti-coercion tool that France strongly backs will end up being used for protectionist rather than strategic purposes.

Finally, to realise its ambitions for the EU, France needs Germany on board. Macron may have been soft on Russia and China but Germany has hitherto proved mushy to the point of liquefaction. German industry has criticised Lithuania’s defiance towards Beijing and is lobbying against decoupling from China. Earlier this week, Philippe Léglise-Costa, France’s ambassador to the EU, sounded distinctly lukewarm about a confrontation over Lithuania. He told a Brussels seminar that, while member states should show solidarity with Vilnius, the EU should pursue any violations of trade law through the usual channels at the World Trade Organization and seek a negotiated solution.

French cavalry charges have historically been magnificent to watch, but in an EU context they are more often heralded than executed. The case for centralising some strategic power in the EU is strong. But Macron’s ability to deliver will require more European unity and French domestic resilience than are currently on display.

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IMF warns of ‘multiple challenges’ to global economic recovery



The global economic recovery from coronavirus will run into “multiple challenges” this year, the IMF said on Tuesday, warning of lower growth and higher inflation.

Significantly downgrading its 2022 forecasts for economic activity in the world’s two largest economies, China and the US, the updated economic forecasts from the fund show it becoming more pessimistic about the scope for a full recovery from the pandemic.

The outlook would be even worse, the IMF added, if central banks have to take firmer action to quell inflation or geopolitical tensions in Ukraine intensify.

The IMF’s forecast for the global economy is for growth in gross domestic product to slow from 5.9 per cent in 2021 to 4.4 per cent this year, weakening further in 2023 to only 3.8 per cent.

The fund has knocked 0.5 percentage points off its growth forecast for 2022 with only a modest bounce back of 0.2 percentage points for 2023.

Gita Gopinath, the IMF’s first deputy managing director, said in a blog post that the world economy was grappling with supply disruptions, higher inflation, record debt and uncertainty. “The continuing global recovery faces multiple challenges as the pandemic enters its third year,” she said.

“The last two years reaffirm that this crisis and the ongoing recovery is like no other,” Gopinath added. “Policymakers must vigilantly monitor a broad swath of incoming economic data, prepare for contingencies and be ready to communicate and execute policy changes at short notice.”

Column chart of Contribution (percentage points) showing Weakness in China and the US has caused a downgrade in the IMF's 2022 glboal growth forecast

The IMF significantly downgraded its forecast for US economic growth in 2022, from 5.2 per cent in its October outlook to 4 per cent just three months later. It judged that the administration of Joe Biden was no longer likely to pass its Build Back Better legislation.

Even with slower growth, the IMF thought the Federal Reserve would need to tighten monetary policy faster than it previously expected.

“Everything points in the same direction when it comes to monetary policy, which is the need to cool down the economy to bring down inflation,” said Gopinath in an interview with the Financial Times.

Ahead of the Fed’s first monetary policy meeting of the year this week, Gopinath said there was likely to be volatility in markets this year. “This makes the job of the Fed even more important — to very, very clearly communicate how they are reading inflation and how they expect to respond to this over time.”

For China, the fund downgraded the 2022 growth outlook from 5.6 per cent to 4.8 per cent on the back of the restrictions needed to continue with its zero-Covid policy and the retrenchment in the property sector.

But Gopinath did not think a Chinese slowdown stemming from its property sector would derail the global economy. “China has both the monetary and fiscal space to deal with the macro consequences of something like that, and does have some ability to ensure that there is some orderly restructuring and that it doesn’t spill over to financially viable firms.”

The IMF also forecast UK growth to moderate after a strong 2022, with the economy expanding just 0.5 per cent in 2023.

The eurozone growth outlook was maintained albeit with a weaker recovery forecast, reflecting disruptions from the Omicron wave of Covid-19, followed by faster growth in 2023.

Bar chart of Economic growth in 2022 (%) showing Downgrades in growth forecasts for most large economies since October

For almost all of the world, inflation is now expected to be higher this year, requiring central banks to tighten monetary policy and putting pressure on countries to make sure their levels of borrowing come down as the cost of credit rises.

This will put most pressure on emerging and developing economies, the fund said, adding to concerns raised earlier this year by the World Bank. Those with large amounts of foreign currency-denominated debt will be most at risk.

Gopinath said the most important economic policy initiative would be “to break the hold of the pandemic”, requiring a larger and more equitable supply of Covid-19 vaccines, tests and therapeutic drugs.

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Australian inflation surge fuels expectations of interest rate rise



Elevated fuel and housing costs drove Australian inflation to higher than expected levels in the fourth quarter of 2021, increasing the likelihood of an interest rate rise in the second half of the year.

The consumer price index rose 3.5 per cent in the fourth quarter compared with the previous year, and 1.3 per cent from the third quarter, according to data published on Tuesday by the Australian Bureau of Statistics. Economists had expected a year-on-year rise of 3.2 per cent.

The rapid spread of the Omicron coronavirus variant has added to inflation worries. Food prices have risen on supply chain disruptions as supermarkets, retailers and logistics companies have struggled to source workers owing to the country’s isolation policies.

Michelle Marquardt, head of prices statistics at the ABS, said the most significant price rises in the December quarter were new housing, holiday and accommodation costs and automotive fuel, which surged almost a third from a year earlier.

“Shortages of building supplies and labour, combined with continued strong demand for new dwellings, contributed to price increases for newly built houses, town houses and apartments,” she said.

Unemployment hit a 14-year low in December, making for a tight job market, but the spread of Omicron and low migration numbers because of strict border policies have led to a labour shortage.

Shane Oliver, chief economist at AMP, said the data made a rate increase more likely. “So we continue to see the Reserve Bank of Australia raising rates in August with RBA commentary adjusting in a more hawkish direction. At least it’s not the 7 per cent inflation seen in the US,” he said.

Sean Langcake, senior economist for BIS Oxford Economics, said that programmes designed to stimulate residential construction had led to cost inflation for materials and workers, contributing to underlying inflation.

“While some of these cost pressures could still be seen as transitory, we expect the RBA will strike a more hawkish tone at next week’s meeting. A rate rise in 2022 is now more likely in light of these data,” he said.

The RBA said in November that it was unlikely to raise interest rates from its 0.1 per cent level in the short term until inflation was sustainably within its 2-3 per cent target range.

The timing of a potential rate increase could influence Australian elections, which are due to take place in the coming months, with housing prices a crucial issue for voters.

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UK businesses count the cost of surging inflation



Jon Fletcher, general manager of the Grange Hotel near Sherborne in Dorset, was told last week by his drinks supplier that prices would rise by an average of 12 per cent this year, the latest in a punishing round of cost increases.

“Everything is going up,” said Fletcher, who has had to cover similar rises in laundry costs and wages, and has been warned of a substantial increase in his energy bill. “It all adds up; some of it is very big.” 

British companies have warned that their recovery from the pandemic risks being dented by rising inflation as they wrestle with the dilemma of what proportion of the costs can be passed on to consumers.

Glenn Turner, owner of Gloucestershire-based Brightfusion, which makes scientific toys and engines, was forced to put up prices last year by 6 per cent — the first increase on some products in 20 years. He is already planning the next rise for later this year.

Glenn Turner: ‘I have never before experienced price increases coming from all parts of the business . . . supplies, postage, wages, energy, its across the board’ © Anna Gordon/FT

“You worry about how the price increase impacts your sales — and ultimately your business,” said Turner, who also runs Maidenhead-based Kontax Engineering.

“I have never before experienced price increases coming from all parts of the business . . . supplies, postage, wages, energy, its across the board. We know we have tax increases coming in future too. I am making a loss on some products owing to the increase in costs.”

UK inflation rose to 5.4 per cent in December, the highest rate in 30 years. This has been driven by a broad range of factors, according to economists, but underpinned by policy decisions by central banks to keep rates low and pump cash into economies to help mitigate the effects of the pandemic.

Line chart of CPI inflation (annual % change) showing Economists expect UK inflation to peak in the spring

The inflationary pressure from the resulting consumer and corporate spending has been exacerbated by the energy crisis, a labour shortage that has pushed wages up and global supply chain disruption that has triggered higher costs for shipping and distribution.

Steffan Ball, UK chief economist at Goldman Sachs, said the bank had revised up its estimates for inflation this year from 5.7 per cent to 7.2 per cent. “It’s a significant increase and it will be felt. We now assume the Bank of England will hike rates in February and May.” 

Inflation is a key risk to the economic recovery, according to Tony Danker, director-general of the CBI business lobby, and has become most companies’ top concern.

“Input costs have been followed by higher wage expectations and taken together with energy prices, something has to give,” said Danker, who called on ministers to help smooth the “cash flow crunch” for small businesses and take action on energy costs.

“Either this means yet more price rises and a bigger hit to the consumer, or it means less investment from falling margins and a worsening supply side.”

Line chart of Annual growth in prices of materials and fuel (%) showing Input prices paid by UK manufacturers have been rising at record rates

Different industries are being affected by a variety of cost increases — from wages in the hospitality industry to raw materials and shipping in manufacturing and retail.

Russell Weston, managing director at Snowbee, a Plymouth-based design and manufacturing company specialising in fishing tackle, said the biggest expenditure item was the “exorbitant” charges being levied by shipping companies.

Russell Weston: ‘They are all charging whatever they can get away with’ © Snowbee

“They are all charging whatever they can get away with,” he said, pointing to the cost of bringing a container from Asia rising from £1,650 before the pandemic to £9,500.

Energy costs have doubled, he added. “It’s absolutely crippling. It affects every single consumer good coming into this country and it will go down to the consumer. There won’t be any more cheap fridges.”

But companies can only pass on part of the increased costs, according to Fletcher. “We will put prices up but it’s difficult to raise food and beverage to a level that would absorb the costs. People will only spend so much on a pint.”

Inflation is hitting businesses regardless of size, although many bigger companies can withstand the price shocks better than smaller rivals that have fewer financial resources and are often less able to pass on price increases to consumers.

A survey carried out by Iwoca, the small business lender, found that nearly three in four small business owners said inflation was a top economic concern in 2022.

Still, results this month from large listed British companies have started to show how broad the impact of sustained higher prices will be on UK plc.

Retailers from Sainsbury’s, DFS and Dunelm to Topps, B&M and Asos have warned over operating costs inflation. M&S said that food inflation rose from 2.7 per cent in the 12 weeks to December to 3.5 per cent in December itself, but added that it had not yet passed much of that on to customers.

Clothing retailer Next warned that prices would rise by up to 6 per cent in the second half of the year because of shipping costs and wage inflation. Topps Tiles said it had started to pass on costs caused by higher shipping costs and inflation in goods but “as selling prices will increase by a lower percentage than cost prices, we do expect percentage gross margins to be moderately lower”.

The hospitality sector is also suffering. Greggs, the bakery chain, said that inflationary pressures from both ingredients and labour mounted towards the end of 2021 and were likely to remain high in 2022. Whitbread, the hotels and restaurants group, said that it expected inflation of 7 and 8 per cent on about £1.4bn of its costs. Construction is also under pressure, with housebuilder Persimmon warning of material prices rising by more than 5 per cent.

Investors worry that rising inflation will mean that earnings are hit or become worth less in realm terms, leading to a slump in company valuations.

Nick Moakes, investment director of the Wellcome Trust medical research charity, said that inflationary pressures would lead to the toughest investment market since the last financial crisis.

He warned about further pressure in the year ahead, with companies also needing to shoulder the burden of rising national insurance costs in April. “We’re in a world now where inflation is probably a lot more entrenched; it’s going to be difficult to shift.”

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