The Economy Explained: Inflation, AI and What's Coming Next

Description:
Join Jane Kavanagh from AIB's Corporate Treasury desk alongside David McNamara, Chief Economist, for the latest edition of AIB Market Talk. The discussion explores the evolving global economic landscape, the outlook for interest rates and inflation, developments across currency markets, and what it all means for Ireland's economy in the months ahead. 

In this episode, the panel discusses:

• Ongoing geopolitical tensions and their impact on oil prices, inflation and global markets 
 • Why major economies have remained resilient despite inflationary pressures and economic uncertainty 
 • Diverging growth trends between the US and Europe, including the growing influence of AI-led investment 
 • The latest outlook for central banks, including the ECB, Federal Reserve, Bank of England and Bank of Japan 
 • What changing interest rate expectations could mean for borrowers, businesses and financial markets 
 • Recent developments in currency markets, including EUR/USD and USD/JPY, and the drivers behind market volatility 
 • The impact of energy prices on inflation, economic growth and consumer confidence 
 • Ireland's economic performance, including business activity, employment trends and investment growth 
 • Emerging developments in the labour market, including the potential influence of AI on employment trends 
 • Why Ireland's strong public finances and underlying economic fundamentals continue to support resilience despite an uncertain global backdrop

Visit our website and subscribe to receive AIB's Economic Analysis direct to your inbox. Our full legal disclaimer can be viewed here https://aib.ie/fxcentre/podcast-disclaimer.

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Transcript

SPEAKER_00 0:04

You're listening to AIB Market Talk, bringing you financial market insights from AIB's experts.

SPEAKER_01 0:11

Welcome to our AIB Market update, which we are recording today on the 12th of August 2026. I'm Jane Kavner from our corporate treasury desk and following a summer hiatus where we enjoyed the small matter of the World Cup and the global phenomenon that was Mayo winning the All Ireland. We are back at it with an awful lot to discuss in a very short time. To that end, I'm pleased to be joined by ARB's chief economist, David McLamar, who can take us through all that has been happening in the markets and hopefully help us make some sense of it all. So, David, football aside, since last we spoke, there's been a lot going on globally, albeit, you know, if I'm not mistaken, but largely the same headlines dominating since last we spoke.

SPEAKER_02 0:49

Thanks, Jenny. Of course, Mayo been top of the pile for me in terms of summer events, but we've uh discussed enough about that in the office, I think, already. So uh on to more global events. I think you know the geopolitical scene continues to rumble on. The war in the Middle East looks like it's sort of unending. Um, but it appears that you know kind of markets are looking through that now. Um and what you're you're seeing is oil prices trading in a fairly narrow range, you know, some volatility where all might spike above $90, but generally in around $80 to $90 trading. So a long way from where we were at the peak back in March, which was you know $120, $130 a barrel. But it's still a very big risk. Uh, and as I said, there's no sign of any any peace deal uh forthcoming. Um, so oil prices are you know are are going to be higher this year overall, uh, and that will have implications for inflation. I suppose the question is how long, how long does that last? We think that you know we'll we'll see higher inflation into or or above target inflation well into 2027 and before you start to see kind of supply and demand rebalance. So that's really been the key, and I suppose the key driver uh globally, uh and then obviously other factors in the background as well, such as you know, closer to home, you know, the war in Ukraine that's still having an impact on markets. See, for example, we've seen related to that and to the Middle East, for example, uh European gas prices start to ramp up. And that that's not really an issue right now um this summer, but as we get into the winter season, if we have a very cold winter like we've had a very hot summer, um, then that starts to become a factor as well. So that's sort of fallen under the radar to a certain extent, but very much driven by commodities, geopolitics. And I don't think that's going to change anytime soon.

SPEAKER_01 2:34

Yeah, you know, you took the next question out of my mouth almost because the economies have been resilient enough, haven't they, over the last couple of weeks or months even? But just going back to what you said, we are coming into the winter months now. Um, is it is is there potential for that to significantly change your impact, do you think the economy is globally?

SPEAKER_02 2:53

It could do. Um, but so far I think resilient is the best way to describe it. If you look at various indicators, you know, there are signs, obviously, that you know, inflation has had an impact um, certainly on business and consumer confidence. But in terms of actual demand and spending and investment in the economy, um, you know, I think it's been it's been a fairly steady as she goes uh type of situation. And if you look at some things like the surprise indices, which are macro indices that we track versus, you know, which is how data is outturning versus expectations, continuing to beat expectations broadly across most regions. So we were we were in this situation four or five years ago um when we had the the inflation surge back then, where a lot of people were expecting, and and economists, including myself, thought we might see a sharper slowdown in the economy, and that didn't happen. And why is that the case? Well, you know, there's quite a bit of resilience really in the global economy. And if you think about corporate sector, household sector, there's a huge amount of savings, and you know, balance sheets are in a fairly robust position by and large. Now, there are some exceptions to that, particularly if you look at the US. So, so in the private sector, there is a bit of resilience, and there's a I suppose shock absorbers that can, I suppose, soak up some of the impact from the higher inflation. But so far, so good. But as I said, risks in our view are are to the downside. If this thing flares up again in the next few months, you know, then we could be looking at something that's that's a little bit worse than we're we're seeing right now.

SPEAKER_01 4:21

So to just talk about the the economies, they're resilient, but are they performing at the same time, the economies?

SPEAKER_02 4:28

Well, it's it's fairly, I mean, the US continues to outperform, and the AI story is really prevalent there. US consumers still pretty strong. You know, the US economy is growing uh you know north at 2% per year. Uh Europe is struggling to grow at 1%, um, you know, even less than that, you know, German economy closer to zero. So it's a very different situation. So it's sort of, as I said, steady as she goes, but you know, the Europe is certainly not knocking out of the part by any means and has its you know long-running issues in terms of productivity, innovation, and all those things. So it's a very different picture on both sides of the Atlantic.

SPEAKER_01 5:01

Okay, and then look into the central banks, then of course they're on holidays at the minute. But again, as I spoke, uh, Japan and the ECB went for the raise uh in June, I think it was, while the Bank of England and the Fed checked, but plenty of noise as to where next. So let's talk about the ECB first, David.

SPEAKER_02 5:18

Yeah, ECB, I suppose the starting point is important. So ECB was starting at 2%, um, so well below the uh Bank of England uh and the Fed. So ECB cut quite dramatically or uh aggressively over the past couple of years, so it's at a lower base than the other two, uh, and there was a concern there that the impact of inflation could become very embedded in Europe. As I said, Europe has a lot of disadvantages. One of them is that we're a very large energy importer, and those energy price hikes do affect us. Uh, I think the ECB is to a certain extent fighting the last war here, yeah, um, in that they were very much burned by the experience last time, and so they're getting ahead of it. We think they might do another one or two rate hikes uh later in the year or early uh next year. That's not to say that you know that that's the correct thing to do. We don't think it is the correct thing to do given the economy is struggling to grow at 1%.

SPEAKER_01 6:10

That would be aligned of where the markets are, isn't it? In terms of what they're pricing.

SPEAKER_02 6:14

Yeah, so the market's pricing in about another 50 basis points of interest rate uh hikes uh by the middle of next year. So and that's come back a little bit. So the ECB and as you said, uh the Japanese central bank are the only ones to hike so far, whereas the the the Fed and the Bank of England have been uh sitting on their hands.

SPEAKER_01 6:32

And the ECB are going to take. Did I see there's another it's a meeting by meeting approach, really? But there's a what an 80% chance of a hike now in September priced in by the market, is it?

SPEAKER_02 6:40

Yeah, they're thereabouts. So it's it's it's all but a done deal as uh in terms of what the market is pricing. And but you know, these these things can change, and there will be a lot of data between now and the uh and the next meetings in the middle of September.

SPEAKER_01 6:53

Perfect. You mentioned the Bank of England there. There's there's little to talk about there. I'd say you can probably sum that one up in a sentence.

SPEAKER_02 6:59

Yeah, look, it's the the Bank of England are kind of sitting in their hands as well, and there's not much priced in uh for the next couple of meetings, one hike priced in by by December, and potential for one maybe in in November. Um the other the other issue here with the with the Bank of England is they're waiting uh to see what the impact is of the new Prime Minister and the new government on fiscal policy. And and you know, so so that that could be you know, potentially we're looking at maybe looser fiscal policy. What does that mean? That could potentially mean that the the Bank of England decide not to uh to cut as fast as they they might have done, or potentially consider another hike. But it looks like the Bank of England are quite happy where they are, at you know, interest rates you know, close to 4% already in an economy that's growing at about 1%. It it feels like monetary policy is quite tight already in the UK.

SPEAKER_01 7:50

And then moving to the two central banks that are firmly under the spotlight, starting with the Fed, where we've been in a little bit of a a will they won't they? The market was pricing in again, 80%, that number chance of a September hike only a few days ago, now down to I think it was a 42% post the CPI figure there that we had. So, what are your thoughts here?

SPEAKER_02 8:09

Yeah, so less than 10 bips priced in for September for the Fed. And the context here is new chair, new broom. He is very much shaking things up in the Fed. It's been likened to a new CEO coming into a struggling company that has failed to hit its revenue targets. In in the case of the central bank, they've failed to hit their inflation target for five years. Uh, that's a very big failure when you when you have one single uh target to meet. And he's been quite critical of the Fed from the outside. His modus operandi, and in terms of what he said prior to being appointed, is that he thinks rates should be lower in the medium term. Why does he think that? He thinks that the impact of AI technological advances will drive innovation and productivity growth. And when you have productivity growth in an economy, you typically see lower inflation. So that's his big bet. He so far in the job, he has kept his cards close to his chest. The market doesn't like it because the statements are incredibly short. Forward guidance is out, um, there's little to no guidance. And he played for time, you could say, by announcing five task forces which will be externally driven, which will report back on the structure and the operations that fail. So without getting into the details, that's his, I suppose, cover to shake things up. And so that they're not expected to be uh completed before the end of the year, maybe, maybe the beginning of next year. And at that stage, I expect you will start to see him reveal his hand and ultimately he wants to push for lower interest rates. That's quite difficult to do given inflation is is well above target now, albeit we had data today which was in line and the core rates continues to trend lower 2.5% or around 2.5% CPI. So I think he'll ultimately he'll he'll probably get his way. But in that interregnum, um there's a lot of volatility in markets, and we've seen that lack of communications from the Fed, I think, drive uh US yields higher over the past few months.

SPEAKER_01 10:11

And they're significantly higher over the last couple of months and more so in the last five or six weeks, an awful lot of that activity happening, Dave, right?

SPEAKER_02 10:19

Yeah, so particularly at the long end of the curve, US uh treasury yields over the over the last six months are up about 50 basis points. So if you look at the 20-year, 30-year, which are particularly important in terms of driving a cost of borrowing, particularly mortgage rates in the US, are quite sensitive to government borrowing costs, uh, less so on this side of the Atlantic, which are more tight to base rates, central bank rates. So that's really driven that steepening in the curve over the past few weeks. Uh and you've got other factors at play as well, in that fiscal policy in the in the US is incredibly loose, too. So the US is going to be running a deficit of over 7% of GDP. They have to fund that every single year to uh supply treasury bills and bonds. And that is having an impact. Uh, and when you have a central bank who looks like on the face of it, is looking to lower rates at the at the front end, but also at the long end, is probably looking to shrink its balance sheet. That's one of the other key, I suppose, targets for Kevin Wart as chair, is that he thinks the Fed should be focused solely on its its inflation target and all the other stuff is the secondary stuff they should be getting out of, and that includes the quantitative easing. Um, so he I I expect he'll around the turn of the year announce that he wants to reduce the size of the Fed's balance sheet, or as we call it, quantitative tightening. Um and that will have an impact at the long end of the curve, more supply and higher yields. And I expect that's what markets are pricing in at the minute uh in the US in on the US side of the uh Atlantic.

SPEAKER_01 11:50

So we're seeing a little bit of that now. So taking all that into account then, David, in terms of the outlook for the Fed, while the market is pricing in some hikes in the short end, obviously, currently, what's your own view on that? Is that unlikely?

SPEAKER_02 12:07

Our view is quite different, actually. Um, we don't think they'll hike at all uh this year. Now, obviously, that's a very big if. As we said uh at the start there, you know, the the market's pricing in about 40 basis points of hikes, not even two in uh interest rate hikes now uh over the course of the next six to nine months. We don't think the Fed will hike. And in fact, given Warsh's form of what he said, he will probably push ultimately in the next year for right rate cuts rather than hikes. So we can come back to what that means for for currencies, but but you can you know you can surmise from that that that means you know, probably weaker dollar if rates are going to be lower. Or our thesis is correct on that point if rates will be lower than the market's pricing in.

SPEAKER_01 12:46

Lastly, over to Japan, then David, the Bank of Japan hiked rates to 1% there as well. Was it back in June, I think, was it the highest in 30 years and when they hiked it to 1%? And look again, before I move on to the currency, I agree. We've a lot to cover here, but where the consensus is seems to be that they're not done hiking rates yet either.

SPEAKER_02 13:05

Yeah, so expectation that we'll see another couple of interest rate hikes over the next uh six months. Um, you know, it it is quite historic, I suppose, in that the central bank in Japan has been um, you know, to zero to negative rates for for decades. Um they've also had an enormous quantitative easing program. They were the pioneers in that sense uh post the crash in the early 90s, or uh and they began to do that uh in the late 90s and they accelerated that about 10 or 15 years ago. Um, so now we're on the other side and we're seeing inflation in in Japan, and it's been exacerbated by its very weak currency as well. Uh, Japan is a very big importer of energy, oil, other commodities. And so with the currency weakening to you know a 40-year low, that's exacerbating the inflationary shock. And you've also got uh fiscal policy, new prime minister uh and she has talked about um loosening fiscal policy to support the economy. So it's a very different situation. All of a sudden, expectations of inflation are increasing in Japan, and then the actual outturns are starting to fall through. And while the Bank of Japan has moved, it has moved quite slowly, and I think that's all contributed to a very weak yen over the over the course of the last few months.

SPEAKER_01 14:17

Well, that's a nice little sedge with David. Thanks, leading on to our conversations just there and our discussions on the Fed and and indeed the Bank of Japan. So let's talk, Dara Yen. They are the hottest pair in the FX markets currently, I would suggest. And you know, and here come all the big numbers, read the first joint US and Japan intervention last month in 28 years, uh, when the yen touched at 40 or low, not forgetting those interest rates we just talked about at a 30-year high. So away you go there now. Open that suitcase and start unpacking that for us.

SPEAKER_02 14:47

Look, so the the the Japanese authorities have formed here, they've intervened. I think uh this is the third time in the last 18 months. I think that they did so back in April, I think, uh, if I'm not mistaken, uh, the previous year as well. Every time they've intervened, it has been temporary. And it's a bit like holding back the tide for all the reasons I mentioned, fiscal policy is looser, interest rates aren't high enough. The the central bank is continuing to, I suppose, put a cap on yields by buying bonds in the market. And so all of these factors have driven the yen lower. So the authorities intervene and it has a short-term impact, and then we see it revert back. So last you know, the the the action last week by the Fed with support of the US saw a dramatic appreciation in the currency. We went from about 164 uh versus the dollar right the way down to 157. Now that has actually since crept back up to 159, it's sort of we're touching back at 160. And we saw something similar back in April, May as well. So the question is, you know, can they keep doing this? No, is the answer. But why did the, I suppose the more interesting context here is why are the US uh involved in this trade? Uh and the answer is that the US have a very big concern. Back to the thing around the conversation around treasuries, the Japanese authorities are one of the largest holders of US treasuries in the world. Um, if they want to support their currency, i.e., buy their own currency, they need dollars or other currencies to do so. How do they get dollars? They sell their treasury portfolio down, and that is very bad news in the context of treasury yields already north of 5% at the long end of the curve. That would drive yields higher. So the US Treasury Secretary, Scott Besant, uh, was out there on the airways talking about why they took the action that they did. And he's been very forceful in saying we're here to support Japan, but we also expect them to step up to the plate now, i.e., more interest rate hikes, fiscal policy a bit more sensible. Um, but it's very notable that you know the US very much has skin in this game, uh, and they they do not want to see treasury yields rise uh even more than they already have, and they're willing to support the Japanese authorities to get the currency down.

SPEAKER_01 17:00

Do you think there's a chance that they may intervene again, say, if it gets back up to the 164 mark where they last intervened? Albeit it doesn't sound like they want to financially uh intervene. But do you think they might? Is there a trigger point for them?

SPEAKER_02 17:12

Yeah, I think they they probably could. Would they do so on the scale that they did a couple of weeks ago? Unlikely. Um there is other methods of doing so. There there is a uh a scheme that the the US Federal Reserves run, which got spezant is trying to push the Fed to uh lift the cap on that, which was it it's a bit complicated, but it would involve the Fed actually extending its balance sheet further in order to lend dollars to the Japanese authorities. Quite complicated, but draws the Fed into the kind of political sphere, which is where I suppose Borsch doesn't want to be, and he's been criticized as being something of a patsy maybe for for President Trump in pushing for lower yields or lower interest rates. Um so yes, they could get the Fed could get drawn in there, and the the US authorities could certainly do more. What's interesting is the as part of the scheme a couple of weeks ago, they sold Euros and apparently you know caused a little bit of consternation in Frankfurt because the ECB weren't aware of the um of the trade in advance and were only informed on the day or um as it was happening. So all of these things have repercussions across different regions. But yes, they could act again, but ultimately, as I said, you're kind of holding trying to hold back the tide. And so I expect what we'll see is the the Bank of Japan hike interest rates, but also start to reduce their enormous holdings of Japanese bonds, and that will um that will push up yields in Japan and that should support the currency.

SPEAKER_01 18:36

It fascinates me watching that currency perhaps over the last couple of years, just how the intervention happens, but like I say, it only ever seems to be a temporary stock on the highest performing. Moving on to Eurodollar, then you know, and a lot of our customers are keen to know the next direction because I mean ultimately it's actually been really relatively range, right? For all that's been going on the last few months. You know, we've had a two cent trading range maybe in the last two months, six cents the last six months, not suggested there's a team there now for any second, but no, where where do you see it next? It's it failed to break 150 and 80 there in the most recent couple of weeks. We've had payrolls last Friday, which very much disappointed. What's your thoughts on that going out the next couple of months?

SPEAKER_02 19:15

Yeah, so I think if we um our I suppose our view that uh the Fed won't hike interest rates and that the ECB will, and so that interest rate differential should close. That should be supportive for the euro. On the other side of that, oil prices typically when oil prices rise, that is um dollar supportive. Uh hasn't necessarily been the case this time around. Actually, in the initial phase of the uh of the war in the Middle East, actually, you know, we've seen we didn't really see that dollar strength to any great extent. So you've got these cross currents happening, but ultimately we think there's a little bit more euro strength given the interest rate differential is really what drives uh drives currency markets ultimately. Uh so where we are today, 115, we think we can get we can push back up to sort of 116 to 117. And ultimately, if you if you zoom out over a long range uh of time over the past 15-20 years, the dollar is still trading at a very historically strong level. Uh, and our kind of long-term thesis has been that now ultimately, you know, the dollar can't continue to trade at that high level. It's been driven by its outperformance uh in terms of GDP growth that can't last forever. So so over the longer term you would expect further dollar weakness.

SPEAKER_01 20:24

But where's your handle in that day? 120, that kind of level yet?

SPEAKER_02 20:27

Yeah, around 120 north of 120. But I think there's enough cross currents at the minute which will be, I suppose, something of an anchor on the pair. And it's difficult to see it getting above that 120 handle without something very dramatic happening in the next uh year to 18 months.

SPEAKER_01 20:44

I agree. So David, then do you believe the price of oil will continue to influence how your dollar is trading as it is now? For example, you know, back last May, I'm thinking of our last podcast in oil is trading at $106 a barrel and your dollar is trading at $117. However, your office had made a very good comparison there over the last couple of weeks. That, you know, if we see oil trading at $70 to $80 a barrel, dollar might be a little bit weaker, $80 to $90 maybe leaning negative, while $90 to $100 would indicate indicate a deterioration. What's your thoughts on that?

SPEAKER_02 21:16

So yeah, I think that kind of rule didn't hold in the in the early phase uh hugely. Now that you know that overall the dollar did uh you know the dollar did strengthen broadly over the course of those first few months of the year, subsequently weakened. So so yeah, I think that is a good rule of thumb in that you know the US is very large oil producer, energy exporter, net energy exporter, when oil prices are higher, that's usually supportive of the dollar given given those commodities are out priced. So that it is a good rule of thumb. Where we are today, sort of uh in terms of oil prices, where we high 80s as we speak, you know, our expectations is that trends back towards 80 by the end of the year, that should be supportive for the euro when you're thinking about that pair. But it's a very

SPEAKER_01 22:00

gift yeah yeah thanks david we could talk about euro sterling but you know what given it has traded within a penny range only over the last four or five weeks with nothing in the line of sight currently to pull it out of that inertia I want to take it back home to Ireland again. Just very quickly David how is the Irish economy doing through all this and what do the next few months hold?

SPEAKER_02 22:19

So Ireland is is very exposed uh to energy shocks we've talked about this before uh we import the vast majority of our energy or at the end of very long supply chains we're very exposed to supply disruption given we bring in all of our our almost all of our gas the entirety of our oil from the UK or or mainland Europe. On the plus side we have a huge fiscal surplus that the government can put to work to offset the shock and they've done that already by announcing various cuts in excise duties VAT I expect we'll see more in the budget in October. So the government has sort of softened the blow of inflation and in fact actually headline inflation is lower than it would have been because you you've seen prices at the pump reduced by the government in terms of its taxation. So so the Irish economy actually has weathered this pretty well we're we're starting from a strong position if you look at our PMI surveys they're coming back very strongly from a dip earlier in the year employment growth is strong based on what the surveys are telling us business sentiment is recovering demand is strong. So based on those uh indicators everything looks hunky-dory and there are some slight concerns in the labor market. Some of the actual hard data suggest that we're seeing a slight rise in unemployment jobs quote not quite as strong as it as it was a year or 18 months ago and particular in in some segments like you know graduates uh school leaves we're seeing you know we're seeing the data suggests it's a little bit of a tougher labor market or more difficult for those those cohorts to get a foot on the ladder in the labor market. Potentially that's the impact of AI too early to tell but it's an interesting trend to follow I think over the next couple of years. But overall we're in a very lucky position I would say if you look at the Irish economy you know we're benefiting from those big global trends number one AI we're actually seeing the investment by those companies based in Ireland start to impact on our growth figures uh so things like data centers. And number two on the manufacturing space I mentioned this before you know we we're a node in the supply chain of GLPs with the weight loss drugs which has really driven uh our export growth in the past year. And so by look and design our openness to trade our attractiveness to multinationals means we've actually done quite well in the last few months now we are very exposed to those uh those sectors uh but so far that they've come up trunks for us in the last uh in the last couple of years and there's no real signs that the economy has slowed to significantly despite all the geopolitical stuff out there at the minute.

SPEAKER_01 25:04

I'm not too sure I'd like to see what it would look like if the economy did so given from a consumer's point of view it's not getting cheaper at all at the pumps or in the weekly shop I don't think but uh it is good to hear that Ireland Inc or Ireland Limited is performing well. David I think we wrap it up there we've got through an awful lot but it was as always very helpful and very informative. Thanks as always to all our listeners whose questions we always welcome and I hope we've covered as always to stay up to date with latest market developments simply subscribe to AIB's Market Talk wherever you get your podcasts for listening to the latest edition of AIB Market Talk Allied Irish Bank's PLC is regulated by the Central Bank of Ireland.

SPEAKER_00 25:45

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