Benchmark revision shows less worrisome US inflation

Recent increases in US long-term rates surprisingly little impacted by inflation expectations

Even with strong capex, US nonfinancial corporations are generating more cash than they are investing

Investor sentiment worldwide is positive, especially in AI-led Asia

Sectoral shift in US job openings

Meteoric rise in AI-related semiconductor exports fueling South Korea's export boom

Regional Fed surveys showing further manufacturing acceleration in August

Sharp drop in China demand for oil helping to limit impact of Middle East conflict on the price

Decades high real price of copper posing physical challenge to investment boom

Rising US long-term real yields point to strong demand for investment funding

US retail sales accelerate even as consumers remain gloomy

Retail gasoline price still well above pre-conflict level and now rising again

PMIs showing widespread revival of global economy

Crude oil price has returned to pre-conflict level but traffic through Hormuz still subpar

Surging orders for computers and electronics propelling durable goods orders

Next year's inflation forecasts are on the rise and above target

Disrupted global supply chains placing upward pressure on US goods prices

Construction of data centers has overtaken transportation construction in US

Elevated energy prices putting intense upward pressure on input prices around the globe

US is big leader in global surge in private AI investment

Larger-than-usual income tax refunds this year are supporting consumer spending

Sharply rising share of AI-related jobs

Inflationary impact of surge in oil prices larger in Europe than in the US

Futures market thinks the price of oil will recede significantly over the next six months

Recent pickup in US defense orders could help support overall growth ahead

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Andrew Cates

_**Weak growth and divided governments complicate fiscal repair and the investment needed to improve productivity.**_

Europe is caught in a difficult circle. Weak growth is undermining confidence in governments, while political fragmentation makes it harder to agree on the reforms and budgets that might restore it. Higher debt-servicing costs leave less room to reconcile competing demands. Economic disappointment and political division risk reinforcing one another, limiting the ability to strengthen growth.

There is no painless way out. Spending cuts can depress activity and alienate voters, while further borrowing may add to the debt without improving the capacity to service it. Higher productivity offers a more promising escape: AI could raise incomes and tax revenues enough to ease the burden. But the investment needed to secure those gains competes for capital and energy, potentially raising Europe’s costs well before it raises European incomes.

That delay matters for monetary policy. Further ECB tightening might restrain inflation, yet also weaken investment and demand in economies struggling to grow. Europe must therefore improve its capacity to invest and govern while managing the immediate pressures on household incomes and public finances.

**The difficulty of governing**
France illustrates the problem. Its minority government is struggling to secure support for a budget intended to curb the deficit. In Spain, a parliamentary defeat over measures to ease the housing crisis has prompted a snap election. In Germany, regional gains by the far-right AfD are putting the governing coalition under pressure. Different economic circumstances have produced a common difficulty: assembling durable support for difficult choices.

Those choices are becoming more expensive. Voters want better services and relief from living costs, while defence and energy security require greater spending. At the same time, governments must refinance debt issued when interest rates were much lower. Rising interest bills leave less room to satisfy these demands, making political agreement harder just as the cost of failing to reach it increases.

**Weak growth weakens consent**
The roots of this difficulty extend well beyond the latest political disputes. The World Bank’s political-stability measure shows a broad deterioration across advanced economies over the past decade. Germany has suffered a particularly marked decline, whereas Greece and Italy have improved or held their ground after earlier periods of upheaval.


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The familiar distinction between a stable European core and a fragile periphery is consequently less useful than it once was. More troubling, political confidence has weakened even in countries where debt burdens have become more manageable. Better financial ratios have not necessarily brought a stronger mandate to govern.

One reason is that the inflation surge after 2019 raised nominal incomes and reduced debt ratios without necessarily improving households’ living standards. Governments benefited from a change in the arithmetic that many voters experienced as a loss of purchasing power. That is a poor foundation on which to seek consent for further restraint.

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The importance of living standards is apparent in the next exhibit. Across the countries examined, stronger gains in real output per person since 2019 have been associated with greater political stability, with Germany and Greece illustrating the contrast. The relationship does not establish causation, but it underlines the importance of growth to governments’ ability to sustain support for economic policy.

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Voters are more likely to accept higher taxes or restrained spending when they believe their prospects are improving. Stagnation instead turns adjustment into an argument over who must bear the loss. As that argument obstructs reform and investment, the weakness of growth becomes both a cause and a consequence of political division.

The nationalist right has gained influence in this environment. In Germany, mainstream parties’ refusal to cooperate with the AfD limits its route to federal power, but its electoral strength already shapes the debate. Elsewhere, more governments involving the nationalist right are a credible prospect. Their ability to improve economic outcomes will depend on reconciling promises with available resources and carrying through reforms. Winning an election does not resolve the constraints that made voters restless.

**Unequal capacity to adjust**
The scope for policy also depends on the balance sheets governments inherit. Europe’s aggregate position is not uniformly alarming: the composite of economic and political indicators below suggests overall vulnerability is no worse than a decade ago. Yet the differences between countries have widened, leaving a common monetary policy to operate across increasingly unequal economic circumstances.

261007AC4.jpg

The country rankings show where those differences are concentrated.

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France’s debt burden extends beyond the state. Combined public and private borrowing is substantially greater relative to GDP than in Italy, and its private credit burden has increased since 2019. Higher debt-servicing costs can therefore restrain household spending and business investment as well as public expenditure. The resulting weakness in activity could further obstruct fiscal repair.

Italy’s large public debt, by contrast, is partly offset by lower private leverage, a current-account surplus and banks funded heavily by deposits. Greece has also reduced its public debt ratio substantially. These differences are another reason to set aside inherited assumptions about a sound core and a vulnerable periphery, and examine the resources and obligations of each economy as a whole.

The rankings should be read as a summary of these constraints, rather than a forecast of economic outcomes. What matters for policy is how debt, external balances and political capacity interact. A government with limited fiscal room and weak public support will find it particularly difficult to cushion a slowdown while maintaining investment.

**Productivity offers support, not immediate relief**
Stronger growth would ease both the financial burden and the political struggle over how to bear it. With ageing limiting the expansion of Europe’s workforce, much of that growth must come from higher productivity. AI could contribute by enabling workers and businesses to produce more, supporting earnings, household incomes and the tax revenues needed to service public debt.

The difficulty is that the means of securing this improvement impose costs of their own. Computing capacity requires substantial investment, dependable electricity and stronger networks. Governments and technology companies are competing for the finance and physical resources needed to build them, while the returns arrive only as the technology is put to productive use.

Europe may therefore bear part of the cost of the global AI boom before capturing much of its benefit. Competition for capital raises borrowing costs, while expensive energy deters investment at home. Economies burdened by weak growth and heavy debt are least well placed to endure this delay.

Improving power supply, infrastructure and regulatory certainty would help attract the investment Europe needs. But these improvements take time and often require public money, adding to the immediate financing demands they are intended eventually to relieve. Productivity remains the most promising route out of the predicament. It cannot be treated as relief already delivered.

**The ECB’s difficult interval**
The ECB must make policy while that adjustment is under way. Energy inflation may warrant restraint if it spreads into wages and broader price-setting. Yet further tightening could raise debt-servicing costs before new investment has expanded productive capacity, weakening the very spending on which a more durable improvement depends.

The case for caution is therefore economic, not simply political. Higher rates can restrain demand, but cannot supply electricity or secure parliamentary agreement. They can also weaken investment and make fiscal adjustment harder. The ECB must weigh the risk of persistent inflation against the danger of adding to the constraints on growth.

Monetary policy cannot resolve those constraints on its own. Governments must provide credible budgets and the conditions for productive investment, while the ECB judges how much demand restraint is needed to prevent inflation from becoming entrenched. Neither can safely assume that the other will compensate for failures within its own remit.

**What would constitute progress?**
Progress will require more than a temporary improvement in debt ratios or a new set of investment commitments. Governments need to sustain agreement on budgets without sacrificing the spending that raises productive capacity. Businesses need the infrastructure and certainty to put new technology to work. Households need to see that adjustment can lead to better living standards.

The evidence to watch is consequently practical: whether announced budgets are implemented, whether investment expands productive capacity, and whether output per person and real incomes improve. These outcomes will determine whether fiscal pressures ease and political support strengthens, or whether weak growth continues to undermine both.

Higher productivity could break the circle linking weak growth and political division. Until its gains arrive, Europe must manage the costs of adjustment without undermining the investment needed to make that adjustment succeed. There is no easy solution, but the priority is clear: restore the capacity to deliver sustained improvements in living standards.

Europe

Europe’s Growth Problem Is Also a Political Problem

Sharmila Whelan

Korea is emerging from the extraordinary political turmoil of 2024–25, triggered by former President Yoon Suk Yeol’s declaration of martial law in December 2024 and subsequent impeachment. The Lee government has since consolidated its political position, winning 12 of 16 major mayoral and provincial contests in June. 

Political upheaval was not the only challenge. Last year was difficult for Korean exporters too, and external headwinds remain. Korean goods continue to face 15% US import duties, with tariffs on certain products rising by a further 10–12.5% in July 2026 under measures related to forced-labour policies. 

Yet Korea—and its exporters in particular—has bounced back. Riding the global semiconductor upcycle and successfully diversifying export markets, exporters have seen both volumes and pricing power rebound sharply. In August, export volumes rose at a double-digit rate for the ninth consecutive month, climbing 26% YoY, while export prices surged 40.7%. 


261002SW1.jpg

Source: Haver Analytics & Westbourne Research 

Korean exporters are nimble. Production diversification is a game they have been playing for years, well before Trump’s 2025 global tariff war. Exploiting comparative advantages, particularly lower labour costs, Korean companies have expanded assembly operations and supply chains across Asia, increasing their resilience to global trade tensions. 

Vietnam and Thailand are good examples. Korean intermediate and capital goods feed into local production and processing, with Vietnam emerging as an important production base for semiconductors, electronics, rubber and plastics, basic metals and electrical equipment. 

Increasingly, however, these ASEAN hubs are gateways to final demand elsewhere. The share of Korean chip and electronics exports to Vietnam ultimately destined for the US rose from 12.8% in 2016 to 21% by 2022, while China's share increased by more than eight percentage points to 19.4%. Meanwhile, the share absorbed by ASEAN final demand has fallen. 


261002sw02.jpg

Korea has therefore pursued a two-pronged strategy: investing directly in major final markets, particularly the US, while continuing to use connector countries as production hubs. 

The strategy is working. Korean exporters continue to hold their own in major markets—in the US, riding the AI capex wave; in Europe, despite rising protectionism; and in China, despite cut-throat competition, rapid growth in indigenous Fourth Industrial Revolution technologies and weak consumer demand. 


261002sw03.jpg

261002sw04.jpg

**Korea Inc.**

The corporate profit cycle is strengthening, and it is not just chip companies, although they lead the improvement. The cycle bottomed in 2022 but did not move into a firm upswing until 2024, when average returns and EBITDA margins of listed companies rose above their pre-Covid 2013–19 averages. Gross margins followed last year, with all three metrics continuing to improve in the first half of 2026. 

More importantly, companies are now putting those profits to work. Until last year, free-cash-flow yields remained high even as valuations rose, suggesting companies were generating cash but not reinvesting it. This year that has changed. 


261002sw05.jpg

The investment cycle has troughed. Real gross fixed investment has turned positive after contracting from 2Q24 through 4Q25, led by increased spending on IT and semiconductor capacity and R&D. Facilities investment strengthened for a second quarter, rising 6.5% YoY. 

Construction remains the drag. Although the pace of contraction has eased, the sector is being squeezed by a weakening credit cycle, higher interest rates and property measures aimed at reining in prices and speculation. 

Even so, expect the investment cycle to swing upwards as IT-related capex gathers momentum and gross fixed investment begins to outpace economic growth. Leading indicators are supportive: inventory-to-shipment ratios have normalised, capacity utilisation and operating ratios have risen since May, manufacturers are the most optimistic in three months, and machinery demand for equipment investment is growing briskly. 


261002sw06.jpg

The fortunes of Korea Inc.—large companies and the SMEs embedded in their supply chains—remain disproportionately tied to the global semiconductor cycle. For now, that cycle is driving investment higher. 

There are risks. US hyperscalers are starting to pace investment, concerns about AI's unintended consequences are growing, and China's lower-cost open-source models pose an increasingly credible competitive challenge. But demand continues to outpace supply, while greater competition is accelerating innovation and demand for AI hardware. 

There will be ups and downs. Korea's ability to weather a temporary slowdown rests on two things: market dominance and strong corporate balance sheets. 

On the first, Korea is formidable. Samsung Electronics and SK Hynix dominate some of the fastest-growing semiconductor segments. As of 2Q25, Korea accounted for 63% of the global DRAM market, 83% of HBM and 47.5% of NAND chip supply. 

**The Korean consumer** 
Employees of Fourth Industrial Revolution companies—notably Samsung Electronics and SK Hynix—are sharing in their employers' good fortune. Higher bonuses are translating into greater spending on leisure and culture, dining out, automobiles and high-value discretionary goods. 

Consumption in semiconductor-heavy regions is running almost 4% above less-exposed areas. The Bank of Korea estimates the marginal propensity to consume out of after-tax bonus payments at 27% in 2025 and 21% this year. The spillover is now large enough to be visible nationally, accounting for around 2% of last year's growth in private consumption. 


261002sw07.jpg

Great. But not so fast. 

First, the effect remains concentrated in Icheon, Hwaseong and Cheongju—the manufacturing hubs of Samsung Electronics and SK Hynix. Second, the BoK estimates the boost to 2027 GDP growth at just 0.06–0.09 percentage points. Third, semiconductors are not particularly labour intensive: the industry's employment-inducement coefficient is only 2.0 jobs for every KRW1bn of additional demand, compared with 4.9 for shipping and 4.3 for motor vehicles. Finally, overall consumption is also being supported by fuel-cost subsidies, EV purchase subsidies and stock-market wealth effects. 


261002sw08.jpg

Economy-wide wage growth is less encouraging. Average wages rose 2.2% YoY in the first half, down from 3.6% a year earlier and barely keeping pace with inflation. Consumer inflation subsequently accelerated to 3.1% YoY in August, while interest rates are rising and household credit growth is beginning to soften. 

The outlook is therefore for a modest, rather than spectacular, consumer recovery—although Korea's consumption story is still stronger than Japan's, where even robust nominal and real wage growth has failed to persuade households to spend. 

**Inflation and monetary policy** 

The BoK has tightened twice this year, most recently raising the policy rate by 25bp in August to 3%. Expect further hikes. Pipeline inflation remains significant, broad money growth is trending higher and the economy can absorb steeper borrowing costs: real lending rates have turned deeply negative. 


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Where to invest? 

We remain overweight Korean equities, with a bias towards semiconductors, electronics, electrical equipment, capital-goods industrials, export cyclicals and banks, the latter benefiting from improving net interest margins. 


Korea (Republic of)

Korea Strikes Back 

Charles Steindel

The US Bureau of Economic Analysis (BEA) estimates that New Jersey’s real GDP grew at a 1.7% annual rate in the second quarter of 2026. This is .5 percentage points under that nation’s 2.2% rate of growth. That gap was the same as in the first quarter of the year, and in line with the longer-trend of New Jersey’s growth averaging slower than the nation by roughly that amount.

The second quarter was the fifth straight to see New Jersey’s economy growing more slowly than the nation’s (despite the longer-term trend, there are times—such as the first quarter of 2025—in which growth here has been higher). The state GDP estimate is built up from estimates of output by industry. A softer performance in manufacturing was the main source of the second quarter gap, while a poorer performance in finance was the major culprit for that in the first quarter.

The story was decidedly difference for personal income. New Jersey’s 5.8% growth rate (in current dollars) was one of the 10 highest in the nation and well above the nation’s 4.8%. New Jersey outstripped the nation in most types of income, most critically in the central “net earnings” (employee compensation plus the earnings of noncorporate businesses) category.

The divergence between New Jersey’s GDP and income showing has been evident for some time. Which set of numbers is more reliable? Estimates of industry output at the state level depend upon some fairly arbitrary assumptions, which raise concerns with state GDP figures, especially the quarterly ones. At least the largest component of state personal income—wages—is fairly well-measured, and the figures for transfer payments to persons are likely reasonably good. The implication is that we may put just a bit more stock in the quarterly income numbers seems to be in loose agreement with the fairly robust numbers the state has been reporting on tax collections.

BEA has also released one bit more state economic data: an estimate of 2025 spending by New Jersey consumers. According to BEA, spending by New Jersey households increased 4.8% (not adjusted for inflation) last year, compared to the national figures of 5.3%--a gap comparable to that we typically see for GDP. State estimates of consumer spending, though, are subject to some of the same concerns as those for state GDP, resting on fairly arbitrary assumptions on the allocation of the national figures across the country.

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- GDP growth gap of .5 percentage points in line with long-term trend.

- Personal income performance one of the best in the nation.

- 2025 household spending trailed the nation.


Viewpoints: September 2023

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