The Global Rate Debate

Summary

Podcast Summary: Thoughts on the Market

Episode: The Global Rate Debate

Date: July 21, 2026
Host: Seth Carpenter, Morgan Stanley's Global Chief Economist
Guests:

• Michael Gapen (Chief US Economist)
• Jens Eisenschmidt (Chief Europe Economist)
• Chetan Naya (Chief Asia Economist)

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Overview of the Episode

This episode digs into the evolving debate surrounding global central bank policy, focusing on the US Federal Reserve, European Central Bank (ECB), and Bank of Japan (BoJ). The panel dissects how resilient growth and persistent inflation are challenging policymakers’ next moves. Discussion centers on inflation dynamics, the role of fiscal policy, and whether central banks have room to maneuver or are backed into a corner.

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Key Discussion Points & Insights

1. The Global Rate Debate Landscape

• Growth and Inflation Dynamics: Global growth has remained stronger than many expected, but inflation, while lower than recent peaks, is still sticking around. New forces—like surging AI investment, government spending, and a possible manufacturing upswing—could stoke demand and complicate central banks' fight against inflation.
  • Seth Carpenter (Host, 00:39): “Global growth has held up probably better than many people expected and inflation, which picked up a lot, started to recede, but it has not gone away.”

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2. United States: The Fed’s Balancing Act

Inflation and Policy Outlook

• Forecast:
  • The team expects US inflation to keep trending down, driven by reversals in energy prices, waning impacts from tariffs, and softer shelter costs.
  • AI-related “chipflation” and software prices are not significant risks, as they represent less than 1% of the consumer basket.
  • Projection: Inflation to drop to ~3% by end-2026, and to 2.5% in 2027.
• Risks:
  • The biggest threat could be unexpected broad-based demand, what Gapen calls “animal spirits,” which might prop up inflation higher than forecast.
• Fed’s Next Move:
  • The Fed is likely to stay on hold if inflation falls as predicted. Only a surprise in stuck inflation—due to, say, energy shocks or sticky goods prices—would justify a rate hike later in the year.
• Memorable Quote:

  • Michael Gapen (01:37):

    “Our expectation is that inflation moves lower to about 3% by the end of this year and closer to 2.5% next year.”

  • Michael Gapen (03:12):

    “If they're patient enough, they'll see enough disinflation to keep them on the sidelines. But the risk is this inflation forecast is too optimistic. Inflation stays firm. The Fed needs to raise rates.”

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3. Europe: Nuanced Policy Tensions for the ECB

Inflation Resilience & Fiscal Crosscurrents

• Rate Hike Outlook:

  • ECB already hiked once this year; another hike is expected in September.
  • There’s tension as demand may prove stronger than expected, meaning inflation could stay high even as growth isn’t weak.

• Neutral Policy Debate:

  • ECB rates (1.75%–2.5%) are widely seen as “neutral,” making the case for more hikes less clear-cut compared to the US.
  • Notable Commentary:
    • Jens Eisenschmidt (04:22):

      “It's essentially a nuanced European version instead of the loud American version... Even if they were to increase rates to two and a half in September… you would probably find a lot of people saying, well, this is still a neutral policy.”

• Fiscal Policy Ties:

  • Some ECB council members are wary that ongoing fiscal stimulus could force further rate hikes. However, overall debt burden from higher rates isn’t yet an acute concern—except in cases where political risks spike sovereign spreads (e.g., pending elections in France, Italy, Spain).
  • Jens Eisenschmidt (06:16):

    “There are certainly more concerned members in the Governing Council that would point to exactly that fiscal stimulus as a reason why interest rates have to be increased further from here... with all the political risk that's around the corner... the higher the interest rates are, the larger the spreads could become.”

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4. Asia: Gradualism in Japan and China’s Fiscal Shift

Japan: Slow & Steady Normalization

• BoJ’s Outlook:
  • BoJ likely to hike interest rates twice over the next year—once in December, once the following June.
  • Despite market expectations for more hikes, the panel sees underlying inflation as tepid and largely driven by higher import prices (energy and food) and a weaker yen, not domestic demand.
  • Consumption is largely flat since pre-COVID (up only 1% over 7 years), justifying a patient approach.
• Quote:
  • Chetan Naya (08:02):

    “We think the underlying inflation trend warrants a caution and BOJ to go slowly than what the market is pricing in... Demand when you look at Japan's consumption trend... is just about 1% up over the last seven years. So that's a very tapid trend of consumption demand.”

China: Fiscal Space for Growth

• Surprise in GDP:
  • Weak Q2 GDP, especially in domestic demand and infrastructure.
  • Export sector remains resilient, benefiting from global capex trends.
• Policy Response:
  • China’s government expected to implement more fiscal support in H2 2026—through existing budget channels, not additional stimulus—to try to lift growth from 4.3% to 4.6%.
• Quote:
  • Chetan Naya (10:04):

    “We are expecting that in the back half of the year you will see the government taking up some fiscal expansion, not new stimulus announcement. But whatever they had budgeted, they have enough room within that to... actually increase that fiscal spending towards infrastructure.”

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Timestamps for Key Segments

• Current Global Policy Landscape: 00:39–01:37
• US Fed Inflation & Rate Outlook: 01:37–04:01
• ECB’s Policy Dilemma: 04:01–07:11
• BOJ’s Cautious Normalization: 07:11–09:34
• China’s Growth and Fiscal Path: 09:34–11:06
• Summary/Wrap-Up: 11:06

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Notable Quotes

• Michael Gapen on US inflation risk:

  “I think the real risk is that maybe we underestimate broad based demand, animal spirits. And so you might just see a broad based increase in inflation from stronger demand.” (01:37)

• Jens Eisenschmidt on neutral rates:

  “Even if they were to increase rates to two and a half in September… you would probably find a lot of people saying, well, this is still a neutral policy. That's probably not the case for the US.” (04:22)

• Chetan Naya on Japan’s demand:

  “Demand when you look at Japan's consumption trend and if you index it to 100 at pre Covid levels in September 19th then it's currently about 101 that is that it's just about 1% up over the last seven years.” (08:02)

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Tone and Takeaways

The conversation is measured, data-driven, and analytical—a signature Morgan Stanley approach. Key themes:

• Patience is the approach for most central banks, but risks remain—especially if demand doesn’t cool as expected.
• Europe faces tricky calibration given political risks and fragmented fiscal policy.
• Japan is finally exiting ultra-low rates, but progress is slow due to weak domestic demand.
• China will lean on fiscal leeway to soften otherwise disappointing growth, with no new monetary splashes in sight.

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This episode is a succinct global tour of monetary policy thinking—offering investors and market-watchers a “real-time” look at the biggest issues facing the world's central banks.

Transcript

[A]

Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's global chief economist and head of macro research. And once again today I am joined by Morgan Stanley's chief regional economist, Michael Gapen, the chief US Economist, Jens Eisenschmidt, our chief Europe economist and on the other side of the world, Chet Naya, our chief Asia economist. Yesterday we talked about what's supporting growth around the world, especially AI spending in the US and some government spending in Europe and Asia's role in making all of this happen. Today we're going to try to dig deeper and go into policy. It's Tuesday, July 21st at 10am in

[B]

New York and 4pm in Frankfurt and

[C]

10pm in Hong Kong.

[A]

Since the last time we did this in mid April, I will say the debate around central banks has probably become more complicated. Global growth has held up probably better than many people expected and inflation, which picked up a lot, started to recede, but it has not gone away. And some of the forces helping to shape the economy, the AI spending, government spending, that possible upswing in manufacturing, that could keep demand strong and it might keep pushing inflation higher. So the question today is if growth remains resilient, how much room really do central banks have to navigate? Mike, let me start with you because your call for the Fed here in the US is out of consensus or at least at odds with where the market is pricing things. We talked about the demand going from AI. You pointed out that imports are actually limiting how much domestic demand there is. So what is the underlying story for inflation in the US and what does it mean for the Fed?

[D]

So our view is that inflation will come down in the US So we think disinflation will be driven by some payback in energy prices, some payback from tariffs which have pushed up goods prices over the last year and some further diminishment in housing related inflation, namely shelter. So we think on a broad based perspective inflation has already peaked and will start moving lower. And we think we've seen evidence of this in recent inflation prints. A risk to that though is from the demand side of the economy and AI related inflation in two parts. One, higher software prices chipflation. So the pass through of some of the AI pricing components, fortunately here they're about less than 1% of the consumer basket. So we don't think that there's a great risk, a strong risk, a high risk of AI related inflation in the consumer bundle. I think the real risk is that maybe we underestimate broad based demand, animal spirits. And so you might just see a broad based increase in inflation from stronger demand. That'll be a little bit harder to see in real times. But our expectation is that inflation moves lower to about 3% by the end of this year and closer to 2.5% next year.

[A]

All right, thanks, Mike. And in fact, the most recent inflation report that we just got confirms your perspective that inflation should be coming down. And so I guess the question then remains, what would it take for the Fed to hike this year if inflation has come down like we've seen?

[D]

Well, I think that the answer there is that inflation wouldn't come down in line with our expectations. So if the view is that energy prices, tariffs and shelter inflation should provide plenty of offset and bring inflation down, I think the answer is you don't get payback explicitly. Core goods prices stay elevated. Maybe we get ongoing disruptions in the Middle east that push energy prices higher and create second round effects. So I think inflation just lingering at elevated levels could mean the Fed gets brought in to raise rates in September or later this year. We think if they're patient enough, they'll see enough disinflation to keep them on the sidelines. But the risk is this inflation forecast is too optimistic. Inflation stays firm. The Fed needs to raise rates.

[A]

All right, Jens, what about for you and the ecb? They've already raised interest rates once this year. I think you've got a forecast for them raising interest rates again in September. What could make you wrong about that forecast? What's going to make you convinced that you're right about that forecast? And is there a similar tension that the ECB is wrestling with that Mike talked about for the Fed?

[B]

Yeah, starting with the last part of your question, I think no doubt very similar tension, just that of course it's less obvious. It's essentially a nuanced European version instead of the loud American version that we always stereotypically think the world looks like. So essentially we have here clearly not an AI boom that, I mean, there's no question, and we have discussed that yesterday still, there is certainly the notion that the world demand is not really weak. And some of this will also arrive in Europe. And so you have that tension between maybe there's more resilience than we had thought and so inflation will not come down through to slack as much. And so, so we might actually add something here in terms of monetary restrictiveness. Now the other thing that is often forgotten, even though it's blatantly obvious, the starting point is just different. The ECB is running neutral monetary policy by all accounts, I mean, you could say 2% is neutral and now they are 225. But you know, there are ranges of uncertainty around any estimate and the latest that they published goes from 175 to 250. So basically, even if they were to increase rates to two and a half in September, you could go with the microphone around the Governing Council and you would probably find a lot of people saying, well, this is still a neutral policy. That's probably not the case for the US So I guess this matters here for that debate too.

[A]

All right. Yesterday we talked about lots of different things, but for Europe, we brought up fiscal policy. How do you think about fiscal policy and how it affects monetary policy? And so I'm thinking about two channels. One, how, how much does the ECB care that if they keep pushing up interest rates they're going to increase the debt service burden for countries that are already facing high debt costs? And second, is fiscal policy going to be the extra impetus for inflation that forces even more rate hikes from the ecb?

[B]

I guess it depends on who you ask. Certainly more concerned members in the Governing Council that would point to exactly that fiscal stimulus as a reason why interest rates have to be increased Further from here. The other answer I would give is probably for now at least, the view on fiscal policy is really model based. You look at what type of increase in interest rate gets you essentially more fiscal restraint because there's an increase in interest rate bill and so less spending somewhere else and that gets you basically less stimulus or less growth. I mean, very roughly speaking, I don't think it's a major concern for now. We, we haven't reached yet interest rates where this would start to play a role. I guess again, Europe being fragmented as it is, with all the political risk that's around the corner, think about elections in France and Italy and Spain next year. That will very likely find itself expressed in spreads. And so the higher the interest rates are, the larger the spreads could become.

[A]

So for each of you, there's clearly a role for inflation. One of the risks we'll talk about maybe is inflation expectations and how maybe there's a big shift in what's going on with inflation. But Chetan, that brings me to you and Asia because one economy where they're unquestionably has been a fundamental shift in inflation and inflation expectation over the past several years is Japan. The bank of Japan is on this normalization path where they're raising interest rates. Interest rates have been negative and then zero and now they're gradually raising Things up. Inflation has come back to Japan. Markets are looking at what the bank of Japan is likely to do. Can you tell us a little bit about what our view is for the bank of Japan this year and next and what might make them hike interest rates faster than we think and is there any risk that in fact they hike interest rates slower than we think?

[C]

Yes. So we are expecting BoJ to hike twice from here. The first rate hike is coming up in December of this year and then another one coming up in June of next year. And then we think that, you know, the underlying inflation trend in Japan is not really that strong. So while market pricing is for about three more rate hikes instead of two that we are building in our base case and some of the macro investors are even talking about four more rate hikes, we think the underlying inflation trend warrants a caution and BOJ to go slowly than what the market is pricing in and what the macro investors are saying in and the key part of our framework on thinking about Japan's inflation is that bulk of the explanation to inflation rise in Japan lies in currency moves and secondarily you can look at also the other drivers are more from supply side which is higher energy prices or food prices whereas it's not driven so much by demand. To elaborate further on why it is not driven by demand Demand when you look at Japan's consumption trend and if you index it to 100 at pre Covid levels in September 19th then it's currently about 101 that is that it's just about 1% up over the last seven years. So that's a very tapid trend of consumption demand and therefore we don't think that BoJ needs to rush into hike in a more aggressive pace going forward.

[A]

There is this fundamental shift but boy it's not on a tear and so the BOJ can take its time. Chetan, it's hard to wrap up a conversation about the global economy without talking about China. I get the sense that there's not a lot going on with monetary policy, but we did just see a soft Q2 GDP print against that backdrop, what should we be expecting in terms of policy? Is there any monetary policy coming or is there going to be some fiscal expansion or is China just sort of stuck in this lower gear?

[C]

Yeah Seth, so we were also surprised by the soft GDP print but when you look into the data actually it was interestingly doing well on exports and I mentioned earlier about how the global capex trend is helping Asia. It's definitely helping China too but at the same time, China's domestic demand turned out to be quite weak and particularly in the areas where we think that the policy response can be providing some help. That is infrastructure spending was also very weak and therefore we are expecting that in the back half of the year you will see the government taking up some fiscal expansion, not new stimulus announcement. But whatever they had budgeted, they have enough room within that to utilize that budget and actually increase that fiscal spending towards infrastructure. We have about 2 trillion RMB worth of funds available for the government to go ahead and spend in the second half and then lift that growth trend which has dipped to 4.3% in second quarter to back to 4.6% in back half of the year.

[A]

You know what, maybe that's a great place for us to leave it. We've gone around the world again today, but this time focusing much more on policy. In the US The Fed is facing this interesting situation. We think inflation is coming down. The last CPI print went in our favor and so as a result our forecast is that the Fed doesn't change policy at all this year. But it's going to come down to the data and in particular whether or not Mike and his team are right in terms of where inflation is going. In Europe. The ECB has already raised interest rates once this year. Jens and team are looking for another interest rate hike. The ECB really does seem more sensitive to inflation coming from the energy shock, but there are lots of other crosscurrents that they're paying attention to as well. And then the other major developed market central bank, the bank of Japan, is on this normalization path. They are in the process of raising interest rates, but Chetan pointed out to us that the growth rate is such that they don't have to be in any sort of hurry and they can take their time with that. Mike, Jens Chetan, thank you so much for helping us connect all of these dots and to the listeners. Thank you for listening. If you enjoy the show, please leave us a review wherever you listen and share thoughts on the market with a friend or a colleague today. The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for you.