How to make friends and influence countries

Key Points

• After the embargo on Russian oil, the policy conversation moves to gas.
• We explore Janet Yellen’s “friend-shoring” concept.
• We look at inflation patterns across the Atlantic and pre-view the ECB’s Governing Council meeting.

With a deal struck within the European Union on an embargo on Russian oil, focus is naturally shifting to gas. Policy ideas are emerging around forging “consumer coalitions” to negotiate with suppliers. Setting a maximum price at which operators in the member states could buy natural gas from Russia could be a tempting option for the EU. Gauging the reaction from Moscow to such proposal would not be straightforward though.

Beyond the EU’s own efforts, the West is under pressure to unite further. In a speech last April Janet Yellen advocated “friend-shoring” of supply chains to “a large number of trusted countries, so we can continue to securely extend market access [and] lower the risks to our economy, as well as to our trusted trade partners”. Raghuram Rajan last week criticized this concept from a “North versus South” point of view, making the point that friend-shoring could entail transacting with countries of similar development levels, which could leave developing and emerging countries unable to continue to benefit from globalization to converge towards the standard of living of mature economies. We explore this further. The West could endeavor to build a sphere of influence including some poorer countries, but it could also be tempted to “give up” on the trade integration of the South for reasons of domestic stability: the rejection of cheap labor competition could help with social tensions at home – even if down the road aggregate growth would be impaired. The geopolitical consequences would be significant. A major difference with the old “cold war” is that at the time, the socialist block was an economic non-entity. Today, China’s attraction for developing and emerging countries is real.

We look at inflation patterns across the Atlantic. In our view, the recent convergence is superficial: inflation is less entrenched in Europe than in the US. Still, there might be tentative signs that inflationary pressure is starting to abate in the US and this week’s core CPI release could be interesting. Yet, for now the central banks will remain nervous. We pre-view the ECB’s Governing Council meeting. While chances of a 50 basis points hike in July are rising, we think it remains data dependent (the June inflation print could be key). A good reason to stick to 25 basis points – still our baseline – is that the bond market has not yet been tested for the actual termination of QE. It would make sense for the ECB to take the time to assess how market conditions are shaping up before “going for the jugular”.