My Washington Week | Credit Conditions Update | Japan’s Inflation Wait Is Over | Mexico Nearshoring Slows | EM Monthly: Rate Cut Challenges

Welcome to the latest edition of Essential Economics! This week I was in Washington DC, attending events at the IMF, the Institute of International Finance, and the World Economic Forum. I blog that geopolitics, fragmentation and US outperformance were top of mind for most participants. Following the recent attack by Iran on Israel, our credit conditions committee increased its geopolitical risk assessment while keeping our baseline narrative unchanged. APAC Chief Economist Louis Kuijs argues that Japan’s price and wage-setting behavior is changing, as indicated by the solid recent wage increases that prompted the Bank of Japan to move its policy rate into positive territory. Emerging Markets Chief Economist Elijah-Oliveros Rosen writes that that nearshoring in Mexico is progressing slowly, with the initial impact most noticeable through an increase in private non-residential construction to expand production capacity among the traditional manufacturing hubs. Finally, our latest emerging markets (EM) monthly is out, with Luca Rossi and team concluding that external developments could prompt EM central banks to be more cautious about cutting policy interest rates.

My Washington Week

I spent the week in Washington DC alternating between events for the IMF, the Institute of International Finance (where I appeared on the global macro panel moderated by Enda Curran of Bloomberg News) and the World Economic Forum (where I appeared on the longevity panel). The overall mood was sober but resolute, with geopolitics, fragmentation, and US macro outperformance top of mind for most participants.

To read my blog post containing key insights from the week in Washington, click here.

Also, thanks to Michael Klimes at The Banker for covering the IIF panel.

Credit Conditions Update: Increase in Geopolitical Risks

The recent attack by Iran on Israel represents a dangerous expansion of the Israel–Hamas war and raises the risk of a sharp escalation of the conflict. The signaling and coordination that minimized harm prevented an immediate full-scale regional conflict. While last weekend's events signal a significant increase in geopolitical risk, the central narrative of our base-case scenario remains broadly unchanged, including our baseline macroeconomic assumptions for the major economies.

 Nevertheless, our expectations will be contingent on the nature and magnitude of the Israeli response in the period ahead. 

To read the report, click here.

Japan’s Long Wait for Inflation Likely Ending

Louis writes that price and wage-setting behavior is changing, as indicated by the solid recent wage increases that prompted the Bank of Japan to move its policy rate into positive territory. Changes in price and wage setting will translate to medium-term inflation of 1.5%-2%. This will support nominal revenue growth for firms and the government, thus offsetting the impact of higher interest costs.

The central bank will likely slowly increase the policy interest rate to around 1% by end-2027, significantly lower than those of other major developed economies.

To read the full report, click here.

Mexico’s Nearshoring Advancing Slowly

Elijah argues that nearshoring in Mexico is progressing slowly, with the initial impact most noticeable through an increase in private non-residential construction to expand production capacity among the traditional manufacturing hubs. The next stage of nearshoring will involve attracting more foreign manufacturers and increase production, which will face significant obstacles.

In a scenario in which nearshoring were to boost Mexico's GDP growth to 3%, the manufacturing output growth pace would have to be double what it was in the decade before the pandemic.

To read the full report, click here.

Emerging Markets Monthly: Rising Challenges For Interest Rate Cuts

Our emerging markets team writes that external developments could prompt emerging market (EM) central banks to be more cautious about cutting policy interest rates. The recent rise in commodity prices, particularly oil, increases the risk of renewed inflationary pressure, particularly for net energy importers.

Furthermore, incoming U.S. data have led to a repricing in the federal funds rate, pushing cuts into the future, with a similar impact on benchmark rates in several major EMs, especially in LATAM.

To access our latest EM monthly chart pack, click here.