MNI INTERVIEW: EU Looks At Options To Boost Competitiveness

A proposal to boost the competitiveness of EU products by reducing non-wage labour costs and financing the move by increasing VAT is one of many options under discussion between European Union member states as they seek ways to compete with China, Bruegel senior fellow Alicia Garcia-Herrero told MNI.

Garcia-Herrero, also Natixis Asia-Pacific chief economist, noted that this approach has been mooted in the past without success and was unlikely to be adopted, though it comes as Germany moves closer to France’s more China-sceptic position.

“Reduce the payroll-tax wedge that employers pay, so hiring becomes cheaper, and replace the lost social-security revenue with a higher VAT. The argument is that this would lower unit labour costs for producers while the extra VAT is paid by consumers, including on imports,” she said. “This is the kind of tax-shift that people have talked about for years when they want to improve cost competitiveness without cutting take-home pay."

EU officials contacted by MNI are sceptical that the "Social VAT" idea is practical, given the difficulties of coordinating an increase in VAT rates, which remains a national-level competence of 27 EU member states. (See MNI: EU Aims To Reduce China-Dependence, Avoid Trade War)

FX DRIVE

France continues to argue for an EU push to prompt an appreciation of the nominal Chinese exchange rate, but Garcia-Herrero noted that the Chinese are unlikely to agree such a request, which would anyway be insufficient to repair Europe’s competitive disadvantage.

"Most of the action is coming through the inflation differential and, without a real gain in competitiveness, we cannot do much,” she said.

EU-China talks on trade flows are continuing at technical level, with EU Trade Commissioner Maros Sefcovic talking recently of the possibility of pilot projects involving EU-China cooperation at the level of sectors. The EU is also said to be making progress with its diversification tool, which would require companies to have two to three alternative suppliers of key strategic raw materials and other inputs in order to weaken China's leverage in trade disputes with the EU.  (See MNI: EU Debates Whether 'Made In Europe' Includes Canada)

Garcia-Herrero is also an adviser to the Spanish government and the Hong Kong Monetary Authority. 

MNI: RBA Comments Signal Tighter Policy Ahead - Ex Staff

Recent comments by senior Reserve Bank of Australia officials indicate a hawkish shift that makes one further 25 basis point hike to the 4.35% cash rate more likely and a second increase a strong possibility, former staff told MNI, noting that higher inflation and the risk of unanchored expectations are testing the Bank’s patience.

“CPI came in surprisingly high, and that is an important bit of news for them to be commenting on,” said Peter Tulip, chief economist at the Centre for Independent Studies and a former senior RBA official, pointing to hawkish comments from Deputy Governor Andrew Hauser and Assistant Governor Sarah Hunter this week. “The outlook for interest rates has become much more hawkish, and RBA commentary is in line with that.”

Trimmed-mean inflation was 3.6% y/y in July, unchanged from June but 10 basis points above expectations, while headline inflation eased to 3.5% from 3.8% but was 20bp above expectations, Australian Bureau of Statistics data showed last month.

Tulip believes the Bank will need two further 25bp hikes to contain inflation, but will likely raise rates at either the September or November meeting before pausing to assess further data.

Mariano Kulish, professor at the University of Sydney and a former senior RBA economist, believes the Bank is paving the way for a hike at its Sept 29 meeting, which markets currently price at a 82% probability. “The banks' forecasts in August weren't as hawkish as what the market sees now," he said, pointing to the market's 4.8% terminal rate by Q1. "And then the question is, well is that enough?”

Markets have since moved up their expectations to a 5% rate by June.  

Kulish wants the RBA to raise the cash rate consistently until inflation returns to target, rather than stopping when it merely sees evidence that inflation is likely to fall, arguing the Reserve's recent experience suggests its forecasts have not fully captured the persistence of price pressures, making a wait-and-see approach risky.

STICKY INFLATION

The latest data showed underlying inflation had proved stickier than the Bank expected, he added, following an earlier assessment that excess demand was already too strong and the additional inflationary shock from the Iran conflict and higher oil prices. The RBA needs to communicate more clearly that it is prepared to accept some slowdown in economic activity as part of restoring the balance between supply and demand, he added. 

Tulip said the RBA should focus on the persistence and broader economic effects of supply shocks rather than their origin, with the appropriate policy response depending on whether they ultimately boost or reduce activity. “If the rain comes from a cumulus cloud or a cirrus cloud, it doesn't really make any difference, you still put up your umbrella,” he quipped, noting higher oil prices would warrant stronger monetary policy if their effects proved persistent, while a supply shock that reduced economic activity could limit the need for further tightening.

HOUSING TRANSMISSION

The extent of transmission of higher interest rates through the housing market and into consumer sentiment and spending remains difficult to quantify, Tulip noted, arguing recent market declines should not factor into the Bank's cash rate strategy. 

Kulish similarly argued that the RBA should prioritise its price stability mandate over concerns about the housing market or employment, warning that prolonged inflation above target could eventually push expectations higher. The Bank should be willing to tolerate a greater slowdown in activity if needed to restore price stability and avoid repeating a pattern of tightening too little and too late, he added. 

Tulip said the RBA could ultimately need to tighten more aggressively, but should then be ready to act to reduce rates as the economy responds, avoiding past mistakes of keeping the cash rate elevated for longer. 

MNI ECB WATCH: ECB Hikes By 25BP, Stresses Inflation Risks

The European Central Bank raised its key interest rates by 25 basis points on Thursday as expected, with President Christine Lagarde noting that the unanimous decision was “robust” across all three scenarios managed by the ECB.

Stressing upside risks to inflation and downside risks to growth from the continuing conflict in the Middle East, the ECB retained its meeting-by-meeting, data-dependent approach.

"We didn't debate on future steps", Lagarde said. (See MNI SOURCES: ECB To Re-Stress Inflation Risks With Sept. Hike) "What we will have to do in the future will be determined at each and every meeting", she added, calling today's decision "a no brainer."

 "The conflict in the Middle East continues to generate inflation pressures, and inflation is set to remain well above target for an extended period," the policy statement said, with headline seen returning to target towards end 2027 supported by the effects of higher interest rates. (See MNI ECB WATCH: ECB To Hike As Inflation Risks Persist )

PROJECTIONS

In its new set of staff projections, ECB raised headline inflation for 2027 and 2028 to 2.5% and 2.1%, respectively, but left 2026 unchanged at 3%.

Growth was also revised upwards to 0.9% for this year and 2027 to 1.4% as the economy is proving more resilient than expected, Lagarde said.

Inflation so far has been lower than what the ECB could have expected, said Lagarde, pointing to food prices as an example. But inflation is also proving more persistent, she added, noting that if energy prices are higher for longer due to geopolitical tensions, then food prices too will be pushed up.

MNI INTERVIEW: AfD Success Puts Spotlight On Retirement Reform

The electoral success of the far-right Alternative for Germany should prompt the country’s governing coalition to look again at a proposal to scrap the right of those who have worked for 45 years to retire at 63, though the overall reform agenda will remain intact, an advisor to Finance Minister Lars Klingbeil told MNI.

Jens Suedekum, like Klingbeil a member of the Social Democratic Party, junior partners to Chancellor Friedrich Merz’s Christian Democratic Union, said Berlin needs to face up to the challenges thrown up by last weekend’s state election result in Saxony-Anhalt, where the AfD took 43.8% of the vote on an 80% turnout. His comments add to evidence of SPD nerves over Merz’s reform agenda.

Proposals such as ending retirement at 63 for workers with 45 years of social security contributions, known as “Rente mit 63” may now be up for debate, Suedekum said in an interview.

“What more can be done? That is the acute discussion after the election results in Sachsen-Anhalt. Some people consider that there is a risk the federal government will backpedal on their reform agenda. I don't think that this will happen, because both coalition partners are very clearly committed to moving in that direction,” Suedekum said. 

“That does not mean there won’t be discussions about single aspects of this reform agenda, such as the changes proposed to Rente mit 63, which is a very sensitive issue, especially in eastern Germany,” he said. “But that doesn't mean that you abolish the entire reform agenda. Too much backpedalling would lead to the whole reform package breaking down, and neither the CDU nor the SPD has any interest in allowing that.” (See MNI INTERVIEW: German Pensions Model For EU Reform - Rocholl)

Higher GDP projections suggest reforms enacted so far are starting to pay off, Suedekum said, calling a revision by the Munich-based ifo Institute to its 2026 German growth estimate to 1.4% from 0.8% a “substantive increase.”

Suedekum attributes the improvement to overall exports holding up – “despite a substantive decrease in exports to China and the U.S” and to public investment.

START UPS

Record startups, with more than 3,000 new firms registered this year, provide “further evidence that the German economy is restructuring, and slowly moving away from its old business mode, at the same time as we can see improving cyclical components,” Suedekum said.

However, insolvency rates remain elevated, and Germany’s car industry continues to lose market share and jobs, while private consumption and investment remain “muted.” 

The SPD has pushed for tougher action by the EU on Chinese imports including cars, but Merz and the CDU have been more cautious.

“I think Merz was more convinced by the merits of the old way of globalisation and maintaining good relations,” Suedekum said, pointing to reports that the Chancellor’s stance only toughened following publication in May of a paper warning that Germany could lose up to 70% of its manufacturing output to China over the medium term.

“Even if that figure is a bit too high -- even if it’s more like 50% -- that’s still a gigantic problem, and reforming the pension system and so on will not do anything to change that, or to support the auto industry. So the diagnosis is clear: we have to act.” (See MNI INTERVIEW: Germany To Lose 30% Industry Jobs In 10 Years)

ENERGY ISSUES

Despite European gas storage levels being at a multi-year low of around 64% through early September, the risk of supply shortages and higher prices to German industry should not be exaggerated, Suedekum said.

“I don’t expect the winter to bring any dramatic scenario -- not least because not only is the German economy more resilient in that respect, but we now have the LNG
terminals up and running, and experience of how to deal with acute energy crises if they do arise," he said.

While a jump in Bund yields to 15-year highs make Germany’s growth-driven investment agenda more expensive, that does not undermine the case for spending on renewable energy independence, infrastructure and defence, Suedekum said.

“We’re going to see an increase in the interest rate burden of the federal budget - we already have. But I firmly believe that Germany is not going to lose its AAA rating, given the recent positive surprise in the GDP growth figures.”

MNI INTERVIEW: Financial Stability At Risk From AI - Goldstein

Both the potential bursting of the AI bubble and the destabilizing effects of the technology' s expanding role in financial market trading pose risks to financial stability, Itay Goldstein, a Wharton finance professor who has consulted for regional Fed banks, told MNI. 

“The bubble with AI right now is a very imminent concern,” said Goldstein, who was a discussant at the Kansas City Fed Jackson Hole Symposium last month. 

“Clearly we see very high valuations of AI companies, companies that are exposed to AI and as a result the market as whole because they are so dominant in the market. We saw huge investments, it’s not clear if the business model is going to support the profitability of these investments. And there is a structure that is kind of circular where these firms are investing in each other, lending to each other.”

Goldstein, a former academic consultant at the Richmond and Philly Feds and an ex-visiting scholar at the New York Fed, said it’s always hard to know when an asset bubble is about to pop. But he added that “there is likely to be some correction at some point soon.” (See MNI INTERVIEW: US Financial Stability Risks Rising-Ghamami)

DESTABILIZING BEHAVIOR 

AI also poses risks to the financial system because of its growing integration into financial market trading systems, he said.

“We found in one paper that AI has this tendency to collude, which basically means to act not competitively in a financial market setting. In another paper, which is a little more troubling, we found they have a tendency to inflate bubbles and kind of go into a pattern of bubble and crash that they can profit from,” he said.

“My takeaway from that over time was that we might see a lot of destabilizing behavior coming from AI algorithms trading in the financial markets.”

Regulators will be forced to consider new ways to mitigate collusion and market manipulation, he said, because the old ways of finding hard evidence such as phone calls and emails will not exist when such behavior is coming from AI agents. 

“The detection will have to come from looking at patterns in the data, like what happens to prices, what happens to volume, and trying to form some conclusions from that on whether there is coordination, whether there is collusion or not,” Goldstein said.  

STABLECOINS

The professor’s Jackson Hole discussion focused on a paper about stablecoins. Goldstein remains skeptical about both their benefit as a financial innovation and the likelihood that the vehicle will displace the traditional banking system in any major fashion. 

He worries that the potential benefits of greater payment speeds and lower costs might not outweigh the risks posed to the system by increasingly instant payments. 

“I understand that in the big scheme of things if you get your money a little faster it's better for you. I think we need to ask ourselves what is the value of that, and if the value of that is really that high to sacrifice the stability and the safety of the system. I'm not sure,” he said. 

Goldstein concedes that the traditional banking systems payment plumbing had become a bit antiquated, but he sees the advent of fintechs as merely providing an incentive for banks to boost their competitiveness in the arena of payments. 

“We can’t really think that banks are just going to sit there and see how things are changing in front of their eyes, and they're not going to do anything to respond and to adjust. I think they will certainly take actions in the other direction,” he said.

MNI: China To Further Cut U.S. Treasury Holdings, Advisors Say

China’s holdings of U.S. Treasuries as a proportion of its total USD3 trillion in foreign exchange reserves are likely to continue to fall for several years before reaching a new equilibrium, as U.S. debt becomes riskier and offers lower returns, Chinese policy advisors and academics told MNI.

A backdrop of accelerating global de-dollarisation and growing U.S. debt strains has put China's U.S. Treasury holdings in a long-term, gradual downward channel, according to Tan Xiaofen, a professor at the School of Economics and Management of Beihang University.

Tan expects China's U.S. debt allocation to glide toward a baseline around 15% of total forex reserves, down from 18.5% in July 2026 and 37% in 2018. China will need to retain some U.S. Treasuries for liquidity purposes and strategic leverage, he said. (See MNI: Yuan Seen Appreciating Gradually Over Next Five Years)

China's stock of Treasuries fell to USD633.4 billion in June 2026, from a peak of USD1.32 trillion in 2013 and the lowest since September 2008. China’s holdings now rank third globally, behind Japan’s and the United Kingdom’s.

Tan said China will continue to trim its exposure to longer-term Treasuries, while increasing allocations to short-term Treasury bills, inflation-protected securities, and floating-rate instruments.

The overall reduction has been carried out mainly by not rolling over maturing bonds, while avoiding large active sales, advisors noted, with Wang Dong, a professor at the School of International Studies at Peking University, saying that China should avoid volatility which could further erode the value of its remaining holdings.

GOLD HOLDINGS

According to Tan, China will gradually build a foreign exchange reserve system characterised by "low U.S. Treasuries, high gold, multiple currencies, and broad asset categories.” The expansion of national strategic material reserves and investment and financing under the Belt and Road Initiative could be complementary measures, he said, though Wang said that commodities and Belt and Road projects could not substitute for reserve assets considering their price volatility, credit risk, and liquidity constraints.

The People’s Bank of China has increased its gold holdings for 22 consecutive months, from only 8.6% of total reserves to 10%, which Tan noted is still far below the global average of 27%.

The value of China’s Treasury holdings has declined by USD80-120 billion since 2022. Many of the bonds bear low coupons of 2-3%, meaning negative real returns in today’s inflationary environment, Tan said, pointing to measures including enhanced Supplementary Leverage Ratio rules finalised in late 2025, and the expansion of buybacks which he said were part of a pattern of financial repression.

The real yield on 30‑year Treasury Inflation‑Protected Securities (TIPS) currently exceeds 3%, near a 20‑year high, but Tan argued that these are still risky, and exposed to official U.S. efforts to suppress nominal interest rates alongside persistently high inflation.

INTERNATIONAL ROLE OF YUAN

Questions around the dollar have opened a strategic window of opportunity for promoting the international use of the yuan, advisors said, though they stressed that China still has to make significant policy adjustments to take advantage of this. (See MNI INTERVIEW: Shanghai Speeds Up Global RMB Assets Hub Push)

In the short term, the yuan is more likely to provide a supplementary option for global asset allocation rather than a fully‑fledged safe haven alternative to the dollar, according to Wang. Expanding the role of the yuan will require China to maintain policy stability, expand cross‑border settlement, enhance the depth and liquidity of its bond market, and provide a rich array of hedging tools for exchange rate and interest rate risks, he said.

While sovereign funds have increased holdings of yuan assets, with offshore yuan treasury bonds achieving oversubscription ratios of around 4.7 times, allocation among commercial foreign investors remains weak, Tan noted. Foreign holdings of onshore yuan bonds have declined for 12 consecutive months, with overseas holdings only 1.6%–1.8% of the total.

The wide U.S.-China yield spread of around 300 basis points continues to suppress overseas capital inflows, constraining the pace of yuan internationalisation, advisors noted.

China needs to further open its capital account, increase the flexibility of its managed exchange rate, scale up high‑credit‑quality safe assets and improve cross‑border payment infrastructure, according to Tan, adding the country should bolster the backing of its currency through steadily increasing gold reserves.

MNI POLICY: BOJ's Ueda To Strike Balanced Tone After Sept Call

Bank of Japan Governor Kazuo Ueda will aim to strike a balanced tone and prevent one-sided interpretations of the monetary policy outlook at his news conference following the expected rate hike to 1.25% at the Sept. 17-18 meeting, seeking to limit further yen and bond market volatility in either direction, MNI understands.

BOJ officials are worried a dovish interpretation of Ueda’s remarks could weaken the yen again, benefiting exporters and Prime Minister Sanae Takaichi, who favours easy monetary policy, but increasing upward pressure on inflation. The Bank wants to avoid the yen moving back towards JPY160 against the U.S. dollar. Meanwhile, the Bank wants long-term interest rates to reflect market views on monetary policy and the economy, but is concerned that surging rates could undermine the foundation for economic recovery.

Conversely, a hawkish interpretation could reinforce the yen’s recent appreciation to JPY153.4 and lead markets to price a higher terminal rate and faster hikes, despite the BOJ not yet deciding whether to accelerate the pace of increases. 

While Ueda is unlikely to elaborate on a specific terminal rate or the pace of future hikes – as these will depend on evolving economic and price conditions – his comments on the influence of past hikes on the economy and prices, the time lag before their effects are fully felt, and the cumulative impact of monetary tightening, including the hike expected this month, will represent a key market focus. Ueda is also unlikely to comment on the yen’s recent performance, instead pointing out that a stronger currency theoretically lowers import prices and inflation but can also dampen exporters’ corporate profits.

MARKET HOLIDAY 

Compounding the issue is that Japanese financial markets will close for public holidays following the Bank's policy decision from from Sept. 21-23.

Officials will finalise Ueda's anticipated questions and answers for the press conference after assessing the U.S. Federal Reserve’s policy decision on Sept. 16 and monitoring the market reaction.

MNI reported this week that the BOJ is paying more attention to the balance between accommodative financial conditions and upside price risks as underlying inflation approaches the 2% target, with officials assessing the impact of rate hikes on the economy and prices, including their timing and scale, as well as the conditions that would warrant further increases. (See MNI POLICY: BOJ Sees Scope For Flexible Rate Hikes)