MNI POLICY: Fed In No Hurry But Committed To Taming Inflation

Federal Reserve officials do not appear to be in a hurry to increase interest rates, or worried that they have fallen behind the curve. 

Instead they are signaling a considered and deliberate approach to further tightening after raising  the fed funds rate last week for the first time in three years, seeing no need to rush while reiterating their commitment to breaking the lingering fever of inflation.

At the same time, loose financial conditions suggest the neutral level of rates could be higher than previous estimates, a view reinforced by policymakers’ years-long gradual upward revisions to their longer-run fed funds rate projections, even as they remain uncertain how restrictive policy actually is.

Fed Chairman Kevin Warsh justified last week's hike in part by saying he was hard-pressed to call financial conditions restrictive, and adding that the move had "removed a dose of accommodation." 

Economic activity has strengthened in recent months, providing the FOMC with a flexible buffer to evaluate incoming data and confirm whether price growth is accelerating before taking further action. Tightening among other major central banks should also create some spillover to U.S. financial conditions, helping to tame domestic price pressures. 

"It's likely that another rate hike may be appropriate by the end of the year," New York Fed President John Williams said in London this week. "But we have to see. We're going to collect the data ​and do what we did between July and September.” 

OPEN ENDED

With inflation as the FOMC's predominant focus, the Fed is keen to keep price expectations firmly well anchored. Doubts had crept in among households and businesses about the Fed's commitment to its 2% objective after more than five years above target, prompting Warsh to deliver strong messaging to the contrary upon stepping into the role. 

The situation also makes it harder for the central bank to look through supply shocks as it traditionally might, and Fed officials cannot quite know ahead of time how much tightening will be needed. 

To determine whether a series of one-time price changes could convert into broad-based and persistent price hikes, Warsh has placed an emphasis on "contemporaneous" data and price behavior at the margin.

The breadth of price pressures -- with more than 60% of categories in the PCE price index rising 3% or more -- is flashing warning signs. Commodities, including energy prices, have resumed their spike, an early-warning signal for inflation pressure before it shows up in official CPI reports. 

In addition, the resilient U.S. economy has the potential for "even greater performance," as Warsh put it at his press conference last week, especially as the AI revolution takes hold.

The September Summary of Economic Projections showed the median official expecting one more hike this year while nearly half of the committee sees a further increase in 2027. Markets are pricing in three more quarter-point rate rises by April, including a strong chance of another hike in October. (See MNI INTERVIEW: Fed Rates Likely To Peak 75BPS Higher- Lewis)

"I definitely think that inflation has lingered longer than is healthy," Richmond Fed President Tom Barkin told reporters this week. "And I definitely think that with the exception of AI, the economy is solid but not overheated."

MNI INTERVIEW: UK Wage Deals Look Capped At Around 3%- Attwood

Median UK pay awards for 2027 look like coming in slightly below inflation at around 3%, as companies facing higher costs and tighter budgets offer employees other benefits such as flexible working, the head of a leading pay survey told MNI.

“Pay rises are still expected to be the norm, which is a positive, but the size of those increases is being held back by affordability," Sheila Attwood, senior content manager, data and HR Insights at Brightmine, said in an interview.

"Many organisations are likely -- beyond base pay – to review the wider reward package and recruitment approaches to help retain the skills they need,” said Attwood. “They're looking at affordability against retention, affordability against fundraising, affordability against pay compression, affordability against minimum wage." (See MNI INTERVIEW: Caution Needed On UK Minimum Wage Hikes - IFS )

In the post-Covid world, considerations such as flexible working arrangements can be important for workers, she noted. 

"If you know that flexibility, that hybrid working, is the thing that employees these days put quite a high value on, there are definitely ways in which organisations can manage their pay deals that doesn't necessarily sit within their pay budget.”

LIMITED IMPACT

The cooling labour market of recent quarters is not "having a massive drain on pay reviews yet,” Attwood said. However, the rise in inflation expected later this year, from 3.1% in August, could impact negotiations, as firms are just now "beginning to plan their budgets for January pay reviews, and then towards the end of next month and into January they're planning budgets for April."

Brightmine's 2025 survey saw year-on-year pay deal rises in 2026 of 3.2%. Through July, the Office for National Statistics said regular earnings – which are not directly comparable -- grew by 3.4% y/y.

In this year’s survey of expected pay deals, Brightmine asked companies whether they gave most weight to the inflation rate at the time of the review, or the rate at the time of budgeting, or whether they looked at forecasts of future inflation when setting pay.

"The response from most was 'a combination', although the rate current at the time of finally deciding was second in responses,” Attwood said.

"I don't expect them to match those levels of CPI, but next year's pay review is definitely being thought about in a climate of elevated inflation," she said, though she noted that the extent to which employees are aware of precise inflation data and put pressure on companies to adjust pay accordingly is unclear. (See MNI INTERVIEW: UK Inflation Expectations More Loosely Anchored )

Around a quarter of all private sector pay deals are done in Q1, with around a half set in Q2, according to Brightmine. Most public sector awards are fixed between April and September.

"Employers will think about what budget they've got, and where else can they make moves to make that whole package, the whole offer work for people … and how much weight these potentially hold for employees against having to do big things with the pay budget, which they probably don't have the sign-off from the finance team to do," Attwood said.

MNI INTERVIEW: EU Still Undecided On Tough Action Over China

The European Union’s EUR359 billion a year trade deficit with China is likely to widen further even if trade tensions intensify, with the European Union still undecided on tough action and China’s economic model structurally tilted towards exports, the head of the European Union Chamber of Commerce in China told MNI.

Jens Eskelund, president of the chamber, said the EU’s likely approach to China of imposing tariffs targeting individual industries may do little to curb the country’s overall export expansion because it is competitive across such a broad range of products.

“As long as the European position is to surgically address individual industries where you have an issue, then trade and the deficit can continue to grow, because China is active across all verticals,” Eskelund said. “So we should be careful about assuming that a so-called trade war necessarily means a decline in trade.”

More pain is likely to lie ahead for Europe’s manufacturing industries even if the EU introduces stronger trade measures in the fourth quarter following the current round of consultations with Beijing, said Eskelund, who is also chief representative, China, at A.P. Moeller - Maersk. This situation is likely to persist until China takes steps to address its unbalanced growth model, in which manufacturing output has grown significantly faster than domestic demand, he said.

With the EU split between countries like France calling for a tough approach to China and those like Germany which are more cautious, Eskelund recalled a European official’s observation that “maybe the pain is not deep enough yet” to sustain a united approach on dealing with China’s threat to traditional industries. (See MNI: Germany Wants Tougher Made In Europe Provisions)

He added that China was not currently among the European public’s foremost concerns, though over time sustained pressure from imports could change that and help build political support for coordinated action.

Eskelund cited China reaching around 40% of global manufacturing as a possible tipping point, up from roughly 30% today. At that level, he suggested, trading partners could increasingly question how much more Chinese output their markets could absorb.

The chamber’s annual position paper released earlier this week called on Chinese policymakers to address structural imbalances in the country’s economy to support sustainable economic growth and reduce trade tensions.  (See MNI: EU Aims To Reduce China-Dependence, Avoid Trade War)

TRADE DIVERSION

Eskelund said European businesses were closely watching U.S.–China trade developments at this week’s meeting between the two countries’ leaders in Washington. He warned that tighter U.S. restrictions on Chinese goods could divert still more exports to Europe, increasing pressure on the continent’s manufacturers.

He said 56% of chamber members were increasing their onshoring in China, but cautioned that moving production there and exporting back to Europe could heighten concerns about the region’s competitiveness.

One thing which could help to ease the trade imbalance would be a sustained appreciation of the yuan, Eskelund said, though he declined to predict the currency’s near-term direction.

Chinese investment could also receive a warmer welcome in Europe if it created local jobs, research and supply chains rather than using the region mainly to assemble imported components, he said.

MNI RBA WATCH: Board To Hike On Supply-Driven Inflation Fears

The Reserve Bank of Australia Board is likely to raise the cash rate by a further 25 basis points from 4.35% when it meets next Tuesday and signal a strong possibility of another hike, as it seeks to contain inflation amid persistent supply shocks.

Markets have priced in more than a 90% chance of a hike next week, and see a strong possibility of another 25bp increase by the end of the year, with a terminal cash rate of 5% expected by May.

A hike on Tuesday, following August's hold, would be the Board's fourth 25bp increase this year and lift the cash rate to its highest level since October 2011. (See MNI RBA WATCH: Board Ready To Hike Further - Bullock)

Senior RBA officials have consistently used hawkish language following stronger-than-expected inflation data released in August and the resumption of hostilities in the Middle East, which has heightened concerns about supply-driven inflation.

While unemployment has continued to show signs of weakness, the Board will likely lean heavily on its price-stability mandate to justify higher rates.

ECONOMIC DATA

Unemployment rose 10bp to 4.6% in August, while employment increased by 39,5000, nearly double the consensus forecast for a 20,000 rise, and more than reversing the 15,900 decline in July.

The strong employment gain was accompanied by a 0.2 percentage point increase in the participation rate to 67.1%, expanding the labour force by more than the rise in employment. This pushed the unemployment rate higher and signalled further slack in the labour market.

The most pressing data point for the RBA, however, has been inflation, which prompted the Bank's recent hawkish signalling. Trimmed-mean inflation rose to 3.6% y/y in July, unchanged from June and 10bp above expectations, while headline inflation eased to 3.5% from 3.8% but remained 20bp above expectations. Housing costs also rose 5.0% y/y in July, driven by a 5.7% increase in prices for new dwellings as builders passed on higher material and labour costs.

RBA COMMUNICATIONS

The current market pricing for a 5% terminal cash rate represents a stark departure from the rate path in the RBA's August forecasts, which had the rates peak at around 4.5% by March before falling to about 4.3% by December 2027.

Expectations have shifted following hawkish comments from Deputy Governor Andrew Hauser and Assistant Governor Sarah Hunter, followed by Governor Michele Bullock. (See MNI: RBA Comments Signal Tighter Policy Ahead - Ex Staff)

Bullock also noted during a fireside chat at an industry forum this week that “between 4.5% and 5% [unemployment rate] will probably take enough heat out of the labour market that’ll ease pressure on inflation,” suggesting the latest rise in unemployment is unlikely to alter the Bank's renewed hawkish stance.

FURTHER HIKES

While former RBA economists are split over how far the Bank needs to raise rates to bring inflation down, they agree current market pricing of a 5% peak rate seems too high. Peter Tulip and Mariano Kulish, both former RBA senior economists, see scope for the cash rate to reach at least 4.85%, with former Chief Economist John Simon noting the market's elevated forecast is likely driven more by a lack of clear guidance from the Bank.

“Maybe that's [the market's] best guess, but we really need to see an explanation from the Bank of what their strategy is," he said. "For a long time, their strategy was do the minimum and really stretch this out. They're stepping away from that, but the question is, how far are they stepping away?”

A move to 5% would represent a dramatic reversal of the Bank's recent approach, Simon said.

MNI INTERVIEW: US Debt Path Needs Reform - Morningstar DBRS

The United States could face a debt downgrade in coming years if lawmakers in Washington don't make meaningful changes to the path of America's projected debt pile, according to Morningstar DBRS Senior Vice President Michael Heydt.

"The key concern we have relates to the fiscal outlook," said Heydt in an interview. "We have been clear that the ratings could be downgraded if federal debt to GDP breaches 110% without a credible commitment to to improve the debt outlook."

That would include reforms that change the trajectory of mandatory spending and/or some durable increase in revenues, he said. "Not one-off measures, but kind of more structural reforms to the public finances outlook."

They key issue is not the 110% debt to GDP level but the unsustainable trajectory of its growth, Heydt added. '"If there is a major reform that does improve the outlook substantially and it passes 110 but stabilizes, we're okay with that. That's not as much of a concern." 

DEBT CLIMBING

Still, federal debt held by the public, which excludes intragovernmental debt, crossed a major threshold in early 2026, climbing above 101% of GDP, meaning that the public debt alone is now larger than the entire U.S. economy.

The Congressional Budget Office expects debt to GDP to rise above 110% in 2032. "It's not far off," Heydt said about the level, noting it could come even earlier. (See: MNI INTERVIEW: Ex-CBO Chief Says Yields Will Likely Rise More) 

Morningstar DBRS is the only one of the four largest global credit rating agencies to retain the U.S. at the highest AAA rating, and confirmed that rating last week. Moody’s Ratings downgraded the U.S. credit rating in May last year from Aaa, its highest rating, to Aa1, a tier below, citing the inability of the nation to address large and growing deficits. Standard & Poor’s and Fitch downgraded the United States in 2011 and 2023, respectively.

Heightened political polarization raises the risk that lawmakers may continue to delay the reforms needed to put the country’s public finances on a more sustainable path. Still, Heydt said he anticipates intensifying political pressure for change in coming years, particularly as the Social Security trust fund is projected to run out in 2032, when benefits could be cut by about 22%.

"Political pressures will likely intensify," he said. "The political environment could change and we could see potentially an environment more conducive to to an adjustment."

Members of the House Budget Committee earlier this week held a field hearing in Dallas to discuss creating a fiscal commission to tackle the nation’s soaring debt.

"What we're looking for likely has to be a bipartisan effort to reform spending and/or increase taxes to improve the fiscal trajectory," Heydt said.

The federal fiscal deficit is large, structural in nature, and expected to worsen over time because of higher interest payments and age-related spending, including Social Security and Medicare. From 2026 to 2031, the fiscal deficit is expected to hover around 6% of GDP.

INTEREST COSTS

Another jump higher in Treasury yields will add to the pressure on the government's finances. "It's fair to say higher rates are going to, on the margin, increase the fiscal challenge facing the U.S. government."

The growth outlook is strong but risks are tilted to the downside, he added, expecting growth this year at 2.3%. An escalation in the U.S.-Iran conflict, a reassessment regarding the return on technology investments, and ongoing trade policy uncertainty could weigh on the outlook.

Heydt continues to continues to see significant structural strengths underpinning the U.S. credit profile. It is Morningstar DBRS’ expectation that the Federal Reserve will remain committed to its dual mandate and deliver low and stable inflation.

However, political pressures on the Fed that weaken the quality of monetary policymaking could also weigh on the credit rating, Heydt said. (See: MNI INTERVIEW: Fed Independence Still On Shaky Ground - Judge) 

MNI: Germany Wants Tougher Made In Europe Provisions

Germany is pushing for the European Union to toughen up “Made in Europe” provisions in its proposed Industrial Accelerator Act to ensure countries like China do not use manufacturing bases in third countries to bypass the requirements, according to a non-paper seen by MNI and likely to be discussed by EU industry ministers today.

The IAA aims to boost the resilience of European industry and reduce critical dependencies on third countries by building up domestic production capacity for low carbon basic raw materials and net zero technologies. While France has backed a narrow “Made in Europe” requirement, Germany has advocated for allowing it to include countries with which the EU has trade agreements or which comply with World Trade Organisation public procurement rules. (See MNI: EU Debates Whether 'Made In Europe' Includes Canada )

In the non-paper, Germany says that the IAA "must be structured in such a way that it is possible to react swiftly to activities aimed at adversely undermining " the aims of the legislation.

THIRD COUNTRY ROUTE

It calls for the European Commission to be given a "monitoring mandate" to ensure that nations on which EU industry already has "high dependencies" do not abuse 'Made with Europe' provisions by using production sites in approved third countries purely as export platforms to the EU Single Market.

"Relevant countries could be countries that establish production capacity in a partner country that falls within the scope of ‘Partner’s Origin’ mainly in order to meet the requirements of the IAA and where a significant share of production is targeted for the export into the EU, while at the same time direct high supply chain dependencies of the Union already exist from that third country".

The need to safeguard "critical industrial capacity" should also be considered when the EU decides to opt out a country or company from its approved status under the 'Made with Europe" provisions, the document states. 

The current Irish presidency of the EU is hoping to finalise the Industrial Accelerator Act by the end of the year. China has already indicated its displeasure and has said it is monitoring the legislation.

One EU source described the German call as a "counterbalance" to the current French drive to limit the broad scope of the Commission's initial Made in Europe proposal as the legislation wends its way through the European Parliament and the Council. 

MNI NORGES WATCH: Hikes, 'Prepared' To Hike Further

The Norges Bank raised its policy rate by 25 basis points to 4.5% on Thursday, and said it is prepared to hike again if necessary.

"The Committee is prepared to raise the policy rate further if warranted by the inflation outlook," the summary of its deliberations said.

"The conflict in the Middle East is still creating uncertainty about the inflation outlook, and since June, prices for oil and gas and various other commodities have risen," Governor Ida Wolden Bache said at the press conference following the decision. 

"Higher energy and commodity prices will result in higher costs for many domestic firms and higher prices for imported consumer goods. "

"On the other hand, the krone has appreciated so far this year and is now stronger than assumed in the June projections," she added, noting this "will in isolation pull down inflation."

The Committee took note of recent rate increases by the Federal Reserve and European Central Bank as well as rising long-term government bond yields in many countries, as "more rate hikes are expected in the U.S., the euro area and various other countries." (See MNI RIKSBANK WATCH: Holds And Sees Tightening Later This Year)

"Higher interest rates abroad pull in the direction of higher interest rates also in Norway, among other things, through the effect on the krone exchange rate," Wolden Bache said.

The Committee had also "discussed to what extent the increase in market rates abroad could imply a higher long-term neutral interest rate in Norway," the summary said.

DIVISION ON COMMITTEE

Despite the unanimous vote, the summary highlighted a division over views of the prospects for inflation to become entrenched.

Some believed this risk had "eased somewhat over the summer and that it could therefore be appropriate to await further information and keep the policy rate unchanged to avoid restraining the economy more than needed."

Others noted that inflation was too high and "expressed concerns that the monetary stance [was] not sufficiently restrictive," and emphasised "that unemployment has shown little change in recent months and that the driving forces still indicate that inflation will continue to run above target over the next years.”

CPI inflation was higher than expected in August at 3.3% while the rise excluding energy products and adjusted for tax changes (CPI-ATE) was 3.0%. "The Committee noted that the average of underlying inflation indicators was unchanged in August and stood a little higher than CPI-ATE inflation," the summary said.