Economy in Brief

WOW! What a chart!! Enter the Post-War age of the rediscovery of geopolitics Press reports this morning are all over the new ZEW release that shows that macroeconomic expectations for Germany have jumped sharply to a level of 51.6 in March from 26.0 in February. This, of course, is being heralded as a result of the great German turnaround and Germany discovering that it really needs to provide for its own security rather than to spend its money paying down its debt and letting the U.S. provide its protective defense umbrella. A real epiphany… After years of turning down U.S. entreaties to be more careful with its security that started with Barack Obama and went on to Donald Trump, Germany refused to spend more money in NATO and brushed off Trump's concerns about being linked to Russia through a pipeline. It basically did just about whatever it could to cause Russia to think that the Germans no longer had any interest in NATO which played a part and fueling Russian boldness and its attack of Ukraine. Russia thought Germany would leave NATO to preserve its economic ties to Russia! Wrong. But a war’s start often is based on poor assumptions or hidden factors. Had Germany wanted to spend the least it could on the military, it should have listened to Barack and to Trump. However, it didn't, and so now we have this huge military buildup that is really pushing macroeconomic expectations ahead in Germany. While we can argue about military spending and whether it's good or bad, right now, it's providing the stimulus that Germany and Europe need to jumpstart their economy out of this long period of weakness that stemmed from COVID, its aftermath, and from of the Ukraine invasion by Russia.

Dramatic shifts However, the part of this new survey that is not getting as much attention is that U.S. macroeconomic expectations that were +1.3 in February have dropped to -48.7 in March, a massive drop in one month; the ranking or queue standing of the U.S. macro-expectations in March is at a 4.4 percentile mark which means that since the early 1990s that has been weaker than this only 4% of the time. In contrast, the jump in German expectations have boosted German expectations up to the 75th percentile of their ranking over the same period. The economic situation in March, which is less malleable because it's tethered to what's happening ‘on the ground’ says the euro area is roughly unchanged at a ratio of -45.2. Germany’s situation is also roughly unchanged, slightly improved, at a level of -87.6; but the U.S. current index drops sharply to +6.7 in March from +42.6 in February, down to a 37-percentile standing. I frankly wonder if it's possible for current conditions - actual current conditions - apart from expectations, to deteriorate that sharply in one month but that's the result we have here to report.

Stunning developments On dating back to early 1992, U.S. current conditions have fallen (experienced a deterioration) month-to-month more than they have in March 2025 on only four other occasions and those were generally in the middle of either COVID or a sharp stock market sell off or some clear precipitating event. In this case, I suppose we would say it's the fear of Donald Trump, his geopolitical stance, his government overhaul, and tariffs are driving these changes. Macroeconomic expectations in the United States have deteriorated month-to-month more than this only once, and in Germany macroeconomic expectations have improved more sharply than they have in March only five other occasions in the past. This report from ZEW is a watershed report; it's fair to say we've never seen anything like it in the past because not only are these statistically highly unusual moves, but it is unprecedented to see the U.S. and the German macroeconomic expectations move so sharply in one month in completely different directions. This result is simply stunning.

The nail in coffin of deflation In the wake of these findings, it's not surprising to see that inflation expectations have jumped in the euro area from -18.6 in February to +6 in March. In Germany, they've jumped from -17.9 in February to +7.9 in March while in the U.S. they have jumped from 35.3 to 52.3. The queue standings now for inflation expectations are in the 38.3 percentile for the euro area (since the early 1990s), in the 39.5 percentile for Germany, and in the 71.5 percentile for the U.S. Quite apparently the period where we will worry about deflation and the zero bound, and all of those things is over, and we are back to worrying about inflation...hello darkness my old friend...

Italian inflation shows the headline HICP measure at 0.2%, rising in February slower than the January gain of 0.5%. Core inflation was flat in February after rising 0.3% in January. The Italian domestic headline CPI measure also rose 0.2% in February, a little weaker than the 0.3% gain in January. The core to the domestic CPI was flat in February compared with 0.1% rise in January. Month-to-month inflation slowed. The January-February data generally show inflation contained except for uncomfortable readings for the headlines in January for both the HICP measure and the domestic CPI measure.

Sequential trends Stepping back from monthly data, the sequential HICP measures show inflation moving back up again; there's a 1.7% gain over 12 months that dips to 1.3% at an annual rate over six months then accelerates to a 3% annual rate over three months. In contrast, the HICP core decelerates steadily, rising 1.7% over 12 months, at a 1.4% pace over six months, and settling down to a 1% annual rate over three months. The domestic CPI basically mimics those trends, but the headline CPI is up 1.6% over 12 months, up at a 1.2% at an annual rate over six months and then climbing at a 2.3% annual rate over three months. The core domestic CPI is up 1.7% over 12 months, up at a 1.2% pace over six months and up at only a 0.7% annual rate over three months. Both inflation surveys show uneven inflation in the headlines with the tendency to accelerate against clear decelerating trends for the core. However, the 12-month measures for inflation in Italy on headline and core for either survey are all below the 2% pace sought by the ECB for the target for the overall Monetary Union. Inflation in Italy is contained in the range desired by the European Central Bank

Inflation quarter-to-date The trends for the HICP and for the domestic inflation gauge reveal a headline series that shows more inflation than the core series and for each of them. In the quarter-to-date, annualized headline inflation is above 2%. It’s at 3.2% on the HICP measure and at 2.5% for the domestic CPI measure. However, in each case, the core measures are well below what the ECB seeks for an inflation target with the HICP core at a 1.5% annual rate and with the domestic core CPI pace at 1% at an annual rate. Having the better news on the core is good since that measure trends to be more stable while the headline is especially kicked around by energy prices.

Inflation breadth (diffusion) Generally speaking, inflation in Italy has been under control for some time. Diffusion measures show that inflation is not accelerating in more categories than it's decelerating over 12 months, six months, or three-months. Over 12 months, the diffusion gauge is at 41.7%, indicating that only about 41% of the categories are showing acceleration, the same as over three months, which means that inflation is more broadly decelerating than accelerating.

Monthly inflation diffusion by category However, in terms of categories we find that looking at monthly data, inflation is steadily accelerating for (1) alcohol & tobacco, (2) clothing & footwear, (3) rent & utilities, (4) housing & furniture, and (5) restaurants & hotels. This is a significant number of categories looking at the price changes monthly for December, January, and February. On the same monthly timeline, prices are steadily decelerating for (1) transportation equipment and (2) recreation & culture while (3) education logs zero inflation in each of the most recent three months!

Sequential price trends and extreme price changes Looking at inflation categories over 12 months to 6 months to 3 months, the picture shifts. On this timeline, (1) alcohol & tobacco shows acceleration, (2) clothing & footwear prices show acceleration, and (3) health care tends to acceleration. Prices show decelerating trends sequentially for (1) housing & furniture, (2) communications, and (3) recreation & culture. In terms of extreme price changes over 12 months, communications prices fall 4.9% while rent & utilities, and restaurant & hotel prices each rise by 3% or more. Over three months prices fall by 6.4% annualized for communications; they also fall for housing & furniture, and recreation & culture but fall mildly. Prices rise by 17.9% annualized for rent & utilities and by 5.2% for alcohol & tobacco over three months.

This week, our focus turns to Japan as the Bank of Japan (BoJ) prepares for its key policy decision on Wednesday. While the BoJ has made meaningful progress toward monetary policy normalization, it remains an outlier among major central banks, many of which have already begun easing after previous tightening cycles (chart 1). The rationale for Japan’s shift is clear—after decades of chronic price stagnation during the so-called Lost Decades, the country has finally experienced sustained inflation, warranting a gradual recalibration of monetary policy (chart 2). That said, Japan’s inflation story is not without challenges. A rice shortage has driven prices sharply higher, underscoring supply-side pressures in an economy that remains vulnerable to commodity price fluctuations (chart 3). Meanwhile, wage growth is also picking up, with annual wage negotiations delivering encouraging preliminary results—this spring, it’s not just cherry blossoms that are in full bloom (chart 4). These developments have been reflected in rising Japanese government bond yields and a notable recovery in the yen against the US dollar (chart 5). However, part of this yen strength may also be linked to Japan’s recent divestment of US Treasuries, as the country has significantly reduced its holdings over the past year (chart 6). As the BoJ navigates its policy shift, the coming months will be crucial in determining whether Japan can sustain its inflation momentum without sacrificing economic stability.

Japan monetary policy The Bank of Japan (BoJ) initiated a major shift last year, gradually moving away from its eight-year-long negative interest rate policy, signalling a transition from its ultra-loose monetary stance. Since then, the BoJ has raised interest rates three times, citing positive developments in inflation and wage growth—topics we will explore in more detail shortly. However, as shown in chart 1, the BoJ remains far behind its peers in the policy cycle. Major central banks like the US Federal Reserve, the Bank of England, and the European Central Bank have already completed their tightening cycles and are now easing, as inflation has become better-behaved. Moreover, Japan’s real policy rates remain deeply negative, with low policy rates persisting while inflation continues to rise. Despite this, investors do not anticipate another rate hike during this week’s BoJ monetary policy meeting, with the next tightening move expected sometime in Q3.