Economy in Brief

The INSEE household confidence indicator in January 2025 rose to 91.7 from 88.6 in December; the index sits now at a three-month high; it's still below its October level of 93.5.

• Living standards over the next 12 months are expected to show improvement as the reading moves to -47 in January from -58 in December. • Unemployment expected over the next 12 months is lower with a net diffusion reading of 47 in January compared to 54 in December.
• Price developments show expectations for weaker inflation ahead over the last 12 months. Past price developments move from a reading of three in December to two in January. Looking ahead to the next 12 months, the reading falls to -43 from -33, a significantly weaker outlook for inflation. • The ability to save over the next 12 months is unchanged in January compared to December. The favorability of the savings environment is slightly better at 38 in January compared to 34 in December. • The favorability of the environment for making a major purchase is slightly better but little change, with a reading of -28 in January, up from -29 one month ago. • And the financial situation over the past 12 months as well as the next 12 months is improved slightly from what it was in December. Over the past 12 months, conditions were assessed at -22 compared to -23 a month ago; over the forward-looking next 12 months, the outlook has a reading of -10 in January, an improvement from -14 in December.

Some monthly improvement but still a weak report On balance, however, the household confidence index is weak. We rank it among its various values since January 2001 (Rank % column); the ranking is in its 36th percentile, barely above the lower one-third of its historic queue of data. Living standards over the next 12 months mark a 27.6 percentile standing while the expectation for unemployment over the next 12 months is a relatively high 67-percentile, leaving it in the top one-third of its historic rankings – an uncomfortable level for ‘expected’ unemployment. Note that it does not mean that two-thirds of the respondents expect unemployment. The ranking just means that whatever the level of unemployment that is expected that expectation is higher only about one-third of the time.

Price developments showed that over the past 12 months, the inflation expectation stood in its 52.5 percentile. However, looking ahead, that has dropped-down to its 18.6 percentile; a significant improvement in the outlook for inflation.

The favorability and ability to save over the next 12 months are both high readings and their high, 97th percentile responses to this question, often indicate economic impairment. When the rankings are high for savings, conditions are often under stress. The favorability to spend to execute a major purchase improved slightly month-to-month, as we saw above, but has only a 20-percentile standing, a lower one-fifth reading for the favorability to spend.

The financial situation over the last 12 months had a 54-percentile standing; looking ahead to the next 12 months, it seemed to be slightly weaker with a 48-percentile standard, slightly below its historic median.

The IFO climate gauge deteriorated in January, falling to -26.7 from an index value of -26.0 in December. Climate deteriorated in manufacturing, construction, and retailing; it improved in wholesaling and in services. The wholesale gauge improved from -35 in December to -32.4 in January while services improved to -2.2 in January from -5.6 in December. Clearly, the economy is experiencing cross currents with the important services sector improving but deterioration having a larger impact on overall climate.

Current conditions showed improvement in January with the all-sector index improving to -3.9 from a reading of -6.2 in December. Current conditions improved across the board for all reporting sectors. The largest month-to-month improvements by sector are for wholesaling and services.

Expectations worsened over-all month-to-month. The all-sector reading fell to -23.4 in January from -23 in December. All sectors deteriorated with the exception of services that improved to -17.0 in January from -19.7 in December and wholesaling where expectations were flat at -34.8 in both January and December.

This week, we focus on Japan following last week’s decision by the Bank of Japan (BoJ) to raise interest rates again. That decision brings Japan’s central bank closer to policy normalization, supported by the latest inflation data. However, Japan still has a considerable distance to cover before fully exiting its accommodative monetary policy stance, with the real policy rate remaining deeply negative (Chart 1). A closer look at Japan's inflation dynamics reveals that the recent uptick in price pressures has been driven primarily by fresh food and energy, with specific food items seeing price surges due to supply issues and rising production costs. That said, non-"core core" inflation components continue to show inflation consistently above 2% (Chart 2).

The outlook from here is increasingly supportive of BoJ tightening, including on the wage front. Annual spring wage negotiations have resulted in rising wage hikes in recent years, with the wage-price dynamic beginning to unfold as the BoJ desired (Chart 3). More recent wage data also shows a broad-based increase, though the manufacturing sector was a laggard in November, amid ongoing challenges (Chart 4). Externally, Japan still has considerable ground to cover in terms of monetary policy compared to its G10 peers. The wide yield differentials between Japan and other economies continue to weigh on the yen, creating unfavourable conditions that impact both locals and foreigners (Chart 5). Finally, like other net exporters to the US, Japan faces ongoing tariff risks, with added uncertainty surrounding its investments in the US (Chart 6).

The BoJ’s January decision Last Friday, the Bank of Japan (BoJ) raised its policy rate by 25 basis points to "around 0.5%," marking the highest interest rates in 17 years. Leading up to the decision, markets had already priced in the rate hike, following signals from BoJ officials that further tightening was possible in January. In addition, the central bank released updated economic forecasts, now projecting slightly lower real GDP growth for fiscal year 2024 but higher CPI inflation for both fiscal years 2024 and 2025. The upward revision in inflation forecasts coincided with Japan's December CPI report, which showed a notable increase in price pressures, rising to 3.6% y/y, up from 2.9% previously. However, despite the BoJ's rate hike, Japan still has a long way to go before exiting its accommodative monetary policy stance, with the real policy rate remaining deep in negative territory, as illustrated in Chart 1.

The S&P composite PMIs in January improved across the board, with the exception of India and the United States. In the U.S., the PMI headline dropped back sharply on sharp weakness in the services sector in the month in the face of what had been resiliency and strength.

From roughly February to July of 2024, the persistence of declines by sector especially in manufacturing diminished. However, now things have shifted, and we are again in a period when there seems to be more deterioration. The prevalence of manufacturing AND service sector deterioration together has reappeared.

The Russian invasion was a real catalyst of change for the EU, Germany, France, the United Kingdom, Japan, and the United States. Before Ukraine, the recovery from COVID was under way and both services and manufacturing sectors were running policies that left each sector with 50% or higher ranking in 60% to 100% of countries. After Russia’s aggressive action, both sectors were crushed across all these countries; the service sector rebounded first and from March 2024 to date services stood at a ranking above 50% or more in 60% to 100% of the countries. But in the post-invasion environment, the manufacturing sectors showed only about 20% of reporters above a 50% queue standing for manufacturing. Manufacturing continues to be hard hit and well short of normalcy.

Currently we are in another round of weakness looking at a broader group of early reporters that adds India and Australia into the mix. Still, six-month changes show weakness in at least two of three months or three of five months for manufacturing and service sectors. Together they are falling over the same six-months. The ‘best performance’ on this metric apart from the U.S. is Australia where manufacturing has improved on balance over six months for two months running but only after three months of deterioration on that basis.

U.S. performance is an outlier in several ways. The US service sector fell sharply in January, depressing services as well as the composite metric. But over six-months both US services and manufacturing have failed to worsen together for 16-months in a row.

The U.S. has been an anomaly in terms of international performance characteristics. U.S. manufacturing is weakening on balance over six months in six of the last seven months. But the service sector has risen on balance (over the previous six months) in 12 of the last 13 months.

The new sharp weakness in U.S. services (month-to-month) is an issue of it has any staying power.

The four-year queue standing of the manufacturing across eight countries and three sector readings (for each: two sectors plus a composite) shows only five of 24 of these rankings with standings above the 50% mark (above their respective medians) over the past four years. These readings are manufacturing in India (79.6%), services in Germany (63.3%) and services in the EMU (barely…. at 51.0%), and a 59.2 percentile standing for Japan’s service sector (the same for its composite).