Inflation is really not yet under control

Statistics Netherlands reported this morning that our inflation was 1,2% in December, compared to 1,6% in November. For 2023 as a whole, 3,8% is now in the books, while in 2022 it was still 10,0%. That sounds good, even reassuring. Yet you cannot really say that inflation is under control. As a shot across the bow, I dare to predict that our inflation will shoot up to above 3% in January. I make the following comments.

Firstly, the official CBS figures are based on two different series of figures, which means that CBS is in a sense comparing apples and oranges. From June 2023, the year-on-year inflation figures from Statistics Netherlands have been calculated on the basis of a monthly figure from a new series of the price index compared with a figure from the same month a year earlier, but from the old series. The background is known. CBS calculated energy prices every month using the then applicable rates. When energy prices skyrocketed, Statistics Netherlands overestimated the actual inflation because many households had fixed their energy prices for a longer period of time and were therefore not immediately confronted with those sharply rising rates. CBS therefore developed a new series that better measures what households actually pay. A more realistic picture is obtained from the figures that are purely based on that new series. Calculated this way, inflation in December was not 1,2%, but 1,8%. The first graph shows that the difference has now decreased significantly. For the year as a whole, Statistics Netherlands reports an inflation of 3,8%, but based on the new series it was 7,9%. In 2022 it was the other way around. The CBS figure for that year is 10,0%, while according to the new series it was 6,7%.

Secondly, since March 2023, the inflation rate has been strongly depressed by energy prices, which were about 25% lower in December than a year earlier. This downward effect on the overall inflation rate will decrease spectacularly in the first months of the new year.

Thirdly, the apparently reassuring inflation figure for December masks large differences between the various components. As mentioned, energy prices were much lower (approximately 25%) than in December 2022. Food prices are strongly influenced by energy prices with a lag. If the food price inflation series is lagged by five months, the correlation coefficient with the energy price inflation series is 0,68 – this for the statistics experts. It is therefore logical that food price inflation is now also declining. In December it stood at 5,3%, compared to 7,3% in November and a peak of more than 15% in February. Food price inflation will undoubtedly fall further in the coming months.

Fourth, the differences between inflation in services on the one hand and industrial goods on the other are significant, both in terms of level and dynamics. Inflation in services is very persistent. Although it has fallen from a peak in May 2023 (6,1%) but the decline is slow. In December, prices for services were still 4,1% higher than in December 2022. On the other hand, the rate of increase in prices of industrial goods is declining rapidly. There is now 1,1% on the books for December, compared to a peak of 8,9% in May 2023.

The difference in level and dynamics between inflation in services and industrial goods provides the necessary information about the inflation process. Prices for services are strongly determined by national wage developments. Prices for industrial goods are determined more internationally. They reflect the prices of raw materials, bottlenecks in supply chains and the relationship between supply and demand. Stubbornly high services inflation indicates persistently high wage increases. Low and rapidly falling inflation in industrial goods signals falling commodity prices, the disappearance of the logistics disruptions that arose in the pandemic and the weak international economy.

Stagflation light
On balance, I conclude that it is too early to celebrate the victory over inflation. In January we will be shocked by a sharp increase, perhaps above 3%. In the longer term, much depends on wage increases, which have a major influence on the prices of services. If wage growth does not decrease sufficiently due to the structurally tight labor market, inflation will prove to be persistent. On the other hand, the weak economic situation may lead to a sufficient slowdown in wage growth and at the same time further depress inflation in industrial goods. I realize this sounds like 'on the one hand this and on the other such'. But the reality is that the matter has not yet been settled and that we have never before experienced circumstances like the current one. If I had to make a prediction, I would say that the economic downturn will put pressure on inflation, but that due to wage increases it will remain higher than you would expect with such economic downturn. Call it 'stagflation light'.

Business confidence in the industry continues to decline
Entrepreneurs in the industry did not become any happier in December. Both producer confidence as determined by Statistics Netherlands and the NEVI purchasing managers index fell in December. The CBS index now stands at -3,4, which is lower than the long-term average of -1. The NEVI purchasing managers index fell from 44,9 in November to 44,8 in December. A figure below 50 indicates shrinkage. The NEVI survey is much more extensive than that of Statistics Netherlands. The NEVI figures show that entrepreneurs remain gloomy about new orders and the prospects for production. The latter is quite something, because according to CBS figures, industrial production in our country was already more than 11% lower in October than a year earlier. Where on earth will this go if the expectations from the NEVI survey come true and production continues to decline?  

The international economic picture remains mixed
I will be brief about the international economy. The recovery must initially come from Asia, especially China. However, it is not all very convincing. The various purchasing manager indices in China and other Asian countries give a mixed picture. The same applies to figures on international trade in the region.

The US economy will clearly grow more strongly than expected in 2023. Yet a weakening is in the offing. It has been clear for some time that the labor market is gradually relaxing. The number of vacancies fell in November to the lowest level since March 2021, although it remains historically high. The number of people who voluntarily resigned ('quits') also fell, a sign that it is becoming less easy to find another job.

What will help the American economy is the decreased capital market interest rate. In its wake, the thirty-year mortgage interest rate has fallen by more than 1 percentage point within a short period of time. The American housing market is particularly sensitive to changes in interest rates.

Closing
The Dutch inflation figure for December suggests that inflation in our country is more or less under control. That conclusion seems completely premature to me. We also have to take into account that the inflation rate will skyrocket again in January. Since the strong inflationary effect of energy prices will soon end, the tone of the discussion about inflation will change considerably in the coming months.

The international economy remains weak and vulnerable. There are signs of Chinese recovery, but it is far from convincing. The American labor market is becoming less tight. This indicates a slowdown in growth in the US, but the fall in capital market interest rates in the last two months is giving the economy a boost.

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