Inflation slightly lower, but worries are piling up

According to the CBS measure, Dutch inflation fell slightly for the third month in a row in June: 8,6% year-on-year, from 8,8% in May, with a peak of 9,7% in March. The decrease was mainly caused by energy, where the price increase fell from 104,9% to 83,5%. Core inflation did, however, rise fractionally and now stands at 3,7%.

There is something positive as well as negative about the numbers. First something positive. Any drop is welcome, no matter how small. It is also important to note that the development in the short term is much more positive than the high year-on-year figures suggest. Since March, the absolute price level has fallen by 0,3%. That too is due to energy, because energy prices have fallen by no less than 26,8% since March. The gas price even fell by almost 30%.

Food inflation is on the rise
Then the less positive. First, food inflation is on the rise. In June, food prices were 11,2% higher than a year earlier, from 9,1% in May. And while energy prices have fallen since March, food prices are rising significantly. Since March, those prices have risen by 5,5%. This is very tangible and extraordinarily visible for families.

The second less positive thing is that the European gas price rose sharply in the course of June because of the vicissitudes surrounding the war. In March, the European gas price briefly peaked above €200 per MWh. Subsequently, the price dropped to €85 per MWh in mid-June, but has now risen again to almost €170 per MWh. If that continues, we will definitely see the impact in the July inflation data.

Thirdly, we must realize that rents in our country are more or less frozen. Rents and rents imputed to homeowners make up approximately 22% of the inflation basket. As a result, the rent freeze is dampening the inflation rate considerably. However, rents may rise again in July. We will see how great that effect is when the inflation figures for July are published.

The conclusion is that we are a long way from getting rid of our inflation problem. The government has decided to make another €500 available for the minimum wages as compensation for the increased energy bill. In view of the price development of food, you wonder whether something should also be done for vulnerable families with regard to food.

In the meantime, the House of Representatives has asked to do something for middle incomes. Unfortunately, the term middle-income is not well defined. The idea of ​​using the rising VAT revenues due to high inflation for this is creative and sounds like a sympathetic one. However, we must realize that purchasing power support for anyone will always come at the expense of the budget and we must fear that many families will get into trouble. That's where the priority should be, I think.

Gap between Germany and the Netherlands slightly smaller, but still large
Production in the processing industry in our country was 9,9% higher in May than twelve months previously. Although that is lower than the 14,3% in April, they are remarkable figures. The machine industry again delivered a top performance with a production increase of more than 42%.

I have already pointed out the remarkable difference between the Netherlands and Germany. In Germany, the manufacturing sector produced 1,3% less in May than a year earlier, slightly better than in the previous two months. Germany's problems are well known. The large automotive sector has all kinds of problems and is registering significant minuses. Also, German industry is more dependent on China and Russia than ours. That does not prevent you from wondering how long this considerable divergence between production in the two countries can continue. In the past, the correlation between the production series of both countries was very high. Apparently we have to conclude here that Dutch entrepreneurs deal better with the challenges than their German colleagues.

Recession or not, that is the question
Now that financial markets seem to have absorbed the interest rate hike, the next challenge for investors is whether the US economy will enter a recession. If so, corporate earnings will take a hit and that's not good news for stock prices. The yield curve has historically been a good predictor of recessions. Every recession of the past fifty years has been preceded by a reversal of the interest rate structure. The effective yields on two-year and ten-year US government bonds are now more or less equal. Anyone who wants to use this indicator as a predictor will conclude that it is worth it. According to a Bloomberg model, the recession probability in the US is currently 38%.

It is clear that the rate hike is starting to bite in the US. Activity in interest rate sensitive sectors is under pressure. The labor market also appears to be weakening somewhat. The number of applications for unemployment benefits has been gradually increasing since April. The absolute numbers are still low from a historical perspective, but the trend is upward. That might actually be welcome, because the labor market is overstrained and wage growth is accelerating, threatening a wage-price spiral in the US. The Fed is trying to achieve a soft landing, ie a weakening of the economy that will bring inflation down, without triggering a recession. The Fed has not often succeeded in this in the past.

While it is always dangerous to claim that things will be different now, there are two important differences from the past. Firstly, consumers have a large financial buffer that was built up during the corona crisis. This buffer can be used to maintain consumer spending.

It is also striking that American companies continue to increase their investments. The last picture shows the shipment of capital goods, usually a good proxy for the investment behavior of companies. In the fear of an impending recession, you might expect more cautious behaviour.

Inflation in our country has fallen slightly in recent months. However, I do not like the underlying figures at all. Especially the now rapidly rising prices for food can become a major problem.

Dutch industry continues to perform remarkably well, especially the machine industry. Still, you wonder how long that can go on well, given the much weaker development in Germany. And I haven't even mentioned the danger of gas shortages in our eastern neighbours, or even with us.

The risk of a recession in the US has increased. I am not yet giving up hope that the US will be able to avoid a recession. The strong labor market, the good financial position of households and the continued willingness of companies to invest support my optimism/hope.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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